Court Issues Nationwide Injunction Against Enforcement of Corporate Transparency Act

(Parker Tax Publishing December 2024)

A district court issued a preliminary injunction, effective nationwide, enjoining the Corporate Transparency Act (CTA), 31 U.S.C. Sec. 5336, and the beneficial ownership information (BOI) reporting rule under 31 C.F.R. Sec. 1010.380, based on the court's finding that the CTA is likely unconstitutional. The order stays the January 1, 2025, deadline to file a BOI report with the Financial Crimes Enforcement Network (FinCEN) and thus reporting companies need not comply with the deadline pending further order of the court. Texas Top Cop Shop, Inc., et al., v. Garland, 2024 PTC 426 (E.D. Tex. 2024).

Background

In 2021, Congress enacted the Corporate Transparency Act (CTA) (31 U.S.C. Sec. 5336). The CTA requires entities created under state law, such as corporations and limited liability companies (LLCs), to disclose beneficial ownership information to the Treasury Department's Financial Crimes Enforcement Network (FinCEN). The goal of the CTA is to prevent malign actors from seeking to conceal their ownership of corporations and LLCs to facilitate illicit activity such as money laundering, the financing of terrorism, tax fraud, and human and drug trafficking.

Under the CTA, "reporting companies" must submit to FinCEN a beneficial ownership information (BOI) report that identifies each beneficial owner of the reporting company by full legal name, date of birth, current residential or business street address, and a unique identifying number from an acceptable identification document (i.e., a passport, driver's license, or state identification document). The CTA defines the term "beneficial owner" as an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, exercises substantial control over the entity; or owns or controls not less than 25 percent of the ownership interests of the entity.

The CTA delegates authority to the Secretary of the Treasury to establish an effective date for filing and updating beneficial ownership information reports and to promulgate regulations

regarding these reports. Pursuant to that authority, FinCEN regulations in 31 C.F.R. Sec. 1010.380 state that any domestic reporting company created before January 1, 2024, must file a BOI report by January 1, 2025 (i.e., the Reporting Rule). The BOI report must include the legal name of the company, that company's trade names, the address of its principal place of business or primary location in the United States, the jurisdiction of the company's formation, and the company's IRS taxpayer identification number. Further, the report must include the full legal name of each beneficial owner of the company, their date of birth, their business or residential address, their unique identifying number from an approved identification document, and a photograph of that document. Covered entities have a continuing obligation to update their BOI reports.

The CTA makes it illegal to (1) willfully provide false or fraudulent beneficial ownership information and (2) willfully fail to report complete or update beneficial ownership information. Any individual who violates either provision is subject to a civil fine of up to $500 per day for each day that the violation continues, and may be incarcerated for up to two years and fined up to $10,000.

Texas Top Cop Shop, Inc. (TTCS) is a family-run, Texas corporation based in Conroe, Texas. TTCS sells equipment to first responders out of its single storefront in Conroe and is also a licensed firearms dealer. TTCS does not transact any business through the internet, nor does it sell its merchandise outside of Texas. Only four employees, including the owners, work at TTCS. Though TTCS has determined on its own that it is a reporting company under the CTA, to date, it has not filed a BOI report with FinCEN.

In May 2024, TTCS and other entities subject to the CTA (i.e. the companies) sued the federal government seeking an injunction against enforcement of the CTA. The companies claimed that if enforcement of the CTA is not enjoined, their obligations under it would compel them to incur compliance costs and violate their constitutional rights. The companies asserted that (1) the CTA intrudes upon states' rights under the Ninth and Tenth Amendments; (2) the CTA compels speech and burdens their right of association under the First Amendment; and (3) the CTA violates the Fourth Amendment by compelling disclosure of private information. For each of these reasons, the companies asserted that FinCEN's Reporting Rule is also unconstitutional and should be set aside.

The government responded that two Constitutional provisions authorize the CTA: the Commerce Clause and the Necessary and Proper Clause. Under the Commerce Clause, Congress generally has the power to regulate interstate commerce. The Necessary and Proper Clause allows Congress to make laws that are "necessary and proper" for executing Congress's enumerated powers under the Constitution. According to the government, the CTA is "necessary and proper" for carrying out Congress's powers to (1) regulate commerce, (2) regulate foreign affairs, and (3) lay and collect taxes.

Analysis

The district court granted the companies' motion for a preliminary injunction and stated that the injunction applies nationwide after finding that the CTA and the Reporting Rule are likely unconstitutional. Under the court's order, enforcement of the Reporting Rule in 31 C.F.R. Sec. 1010.380 is enjoined. In addition, the January 1, 2025, compliance deadline is stayed under Section 705 of the Administrative Procedure Act. According to the court, neither may be enforced, and reporting companies do not need to comply with the CTA's January 1, 2025, reporting deadline pending further order of the court.

The court found that the CTA is not justified as an exercise of Congress's power under the Commerce Clause. The court noted that neither the word "commerce" nor any references to any channel or instrumentality of commerce appear in the CTA. The court also pointed out that the CTA is not limited only to those companies that use channels or instrumentalities of interstate commerce. According to the court, the CTA does not regulate an activity within the meaning of the Commerce Clause. Rather, in the court's view the law impermissibly forces companies to engage in an activity (the filing of a BOI report) for the purpose of having an activity to regulate.

The court also found that none of the three enumerated powers offered by the government brought the CTA within the scope of the Necessary and Proper Clause. Regarding Congress's taxing power in particular, the government contended that the CTA is "in aid of a revenue purpose" and helps to "facilitate tax collection." But the court noted that the CTA does not impose any tax whatsoever, and the court found no precedent for upholding a statute as an exercise of Congress's taxing power where the statute at issue does not, in some way, generate some revenue. Further, the court found that the statute could not be considered derivative of the taxing power simply because it may be useful in detecting tax fraud. The court said that to hold otherwise would "unleash a slippery slope" and be a substantial expansion of federal authority, contrary to the Supreme Court's narrow interpretation of the Necessary and Proper Clause.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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