Inset: This post was co-authored by Joe Wallin, a partner in the Seattle, Washington office of Carney Badley Spellman and Jonathan Wilson with the FinCEN Report.
The Corporate Transparency Act (CTA) took effect January 1, 2024. This new federal law will require non-exempt reporting companies to report personally identifiable information for each beneficial owner (each, a “BOI report”) to FinCEN. Each BOI report will need to identify each beneficial owner of the reporting company by applying the definition of “beneficial owner” found in the Reporting Rule. For reporting companies with beneficial owners residing in one of nine U.S. states that have adopted community property laws (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) this will prove especially challenging. This article explores those challenges and proposes some strategies to resolve them.
Identifying Beneficial Owners
The Reporting Rule defines “beneficial owner” as “any individual who, directly or indirectly, either exercises substantial control over such reporting company or owns or controls at least 25 percent of the ownership interests of such reporting company.” The Reporting Rule also defines “substantial control” and “ownership interest” as they relate to the determination of a beneficial owner.
Importantly, each beneficial owner must be an “individual,” meaning a natural person. The Reporting Rule provides rules for attributing ownership to an individual when an ownership interest in a reporting company is held by a non-individual.
For example, if a trust holds title to an ownership interest, the beneficial owner will be either the trustee, the grantor/settler or the beneficiary of the trust, depending on which of them has the power to dispose of all or nearly all of the trust’s assets. 31 CFR §1010.380(d)(ii)(C).
Because the CTA is aimed at preventing money laundering by eliminating the anonymity of beneficial ownership, the drafters of the Reporting Rule made it intentionally broad, hoping to prevent bad actors from circumventing its requirements. Consequently, the Reporting Rule contains provisions that compel reporting companies to attribute beneficial ownership to individuals notwithstanding intermediary arrangements.
For example, the Reporting Rule provides that “an individual may directly or indirectly own or control an ownership interest of a reporting company through any contract, arrangement, understanding, relationship, or otherwise, including joint ownership with one or more other persons of an undivided interest in such ownership interest.” 31 CFR §1010.380(d)(ii)(A) (emphasis added).
It is here that the problem of ownership in a community property state arises. In those nine states that have adopted a rule of community property, the concept provides that two spouses (and sometimes two domestic partners) that own property have a “joint ownership . . . of an undivided interest” in the community property asset.
Joint Ownership in Community Property States
The rules of joint ownership in the nine community property states are generally consistent in that two spouses (and sometimes two domestic partners) are deemed to own jointly all the assets of each other with an equal right and power to keep or dispose of the jointly owned property.
The State of Washington, for example, provides that:
“[Excluding certain property types] property acquired after marriage or after registration of a state registered domestic partnership by either domestic partner or either husband or wife or both, is community property. Either spouse or either domestic partner, acting alone, may manage and control community property, with a like power of disposition as the acting spouse or domestic partner has over his or her separate property . . .” R.C.W. 26.16.030.
The Washington code provides exceptions to the general rule that either spouse may manage and control community, including on prohibitions on transfers without spousal consent for (1) testamentary gifts of more than one-half of the community property, (2) inter-vivos transfers, (3) encumbrances or liens. The Washington code also provides that “where only one spouse or one domestic partner participates in [management of a company] the participating spouse or participating domestic partner may, in the ordinary course of such business, acquire, purchase, sell, convey or encumber the assets, including real estate, or the good will of the business without the consent of the nonparticipating spouse or nonparticipating domestic partner.”
The community property laws of the other eight community property states are generally similar, but unique provisions of state laws may require further inquiry in some situations.
For example, the community property law in Texas provides that “during marriage, each spouse has the sole management, control, and disposition of the community property that the spouse would have owned if single.” Texas Family Law Sec. 3.102(a). Subject to that general rule, however, community property is subject to the “joint management, control and disposition of the spouses, unless the spouses provide otherwise by power of attorney in writing or other agreement.” Texas Family Law Sec. 3.102(c). As a consequence, determining whether a spouse should be designated as a beneficial owner because of a community property ownership in Texas may require counsel to inquire whether the ownership interest in the reporting company was acquired before or during the marriage.
Most community property states have exceptions for property that is acquired by one spouse during the marriage by gift, devise or descent. See, e.g. Arizona Code Sec. 25-211.A.2., Texas Family Law Sec. 3.001(2), RCW 26.16.010 (excluding from community property acquired by gift, bequest, devise, descent, or inheritance). Where applicable, counsel may need to inquire whether an ownership interest in a reporting company was acquired by gift, devise or descent as part of a determination of beneficial ownership in a community property estate.
Including Spouses in the Identification of Beneficial Owners
Following the guidance in Section 380(d)(ii)(A) of the Reporting Rule, which requires the identification of each beneficial who has an “undivided interest in [an] ownership interest” that is more than 25% of the entire ownership interest, reporting companies should include both spouses if either spouse would be a beneficial owner and if that spouse is married and resides in one of the nine community property states and if the applicable community property law does not exclude the ownership interest from the community property of the marriage.
Importantly, this rule of including community property would not impact the reporting company’s identification of beneficial owners who have substantial control by virtue of circumstances that do not involve an ownership interest. For example, if an individual is a beneficial owner because that individual is a senior officer of the reporting company, the fact that the individual has a spouse and resides in a community property state would be irrelevant. The non-senior officer spouse would not have any control or influence over the reporting company.
In contrast, an individual might be a beneficial owner (even if their ownership percentage was less than 25%) if their ownership interest gave them substantial influence over major decisions of the reporting company. For example, an investor might have an ownership interest tied to a veto right over major decisions. Such an investor would be a beneficial owner because of the substantial control that comes from the veto right (even if the investor’s percentage interest was below 25%). If that investor were married in a community property state, absent some agreement to the contrary, the investor’s spouse would have a power to vote the investor’s interest and should also be designated as a beneficial owner by the reporting company.
Reporting companies should, consequently, question their beneficial owners regarding their marital status and state of residence. That inquiry may also need to focus on the means by which the beneficial owner acquired the ownership interest in the reporting company. The reporting company should consider, for each beneficial owner who is married in a community property state, whether that beneficial owner’s spouse should also be designated and reported as a beneficial owner.
In addition, if any spouses are designated as beneficial owners are a result of the community property rule, the reporting company should incorporate those spouses into whatever tracking and reporting mechanism the reporting company utilizes to track changes in beneficial ownership and changes in beneficial owner BOI.
Alternative Approaches
Many reporting companies are implementing changes in corporate governance to account for the information flows required by the CTA. Reporting companies can adopt a compliance policy and amend their constituent documents so that investors are required, as a matter of contract, to provide the reporting company with BOI information for their beneficial owners.
Such compliance policies can also involve reporting mechanisms and tracking systems, so that any change in beneficial ownership, or any change in a beneficial owner’s reported data, is brought to the attention of the reporting company’s management. Such a system makes it possible for management to ensure that the reporting company files an amendment to a prior BOI report when it does.
With respect to the community property rule, it might be possible to avoid having to report the BOI of a spouse who is not involved in the business by having the two spouses enter into a separate property agreement through which one spouse might renounce or transfer to the other spouse that spouse’s community property interest in shares. Of course, the parties should consult the applicable state law to determine the enforceability of such agreements, especially in the context of a dissolution proceeding. Counsel should also consider the prudence of such an approach in view of the policy reflected in the Reporting Rule that tends to include as a beneficial owner all close cases. Because of the potential criminal penalties that could attach to an effort to exclude a beneficial owner who ought to have been included, it might be prudent to seek a no-action letter from FinCEN before relying on any side agreement that would exclude an individual from beneficial owner status.
Conclusion
The CTA is going to usher in a new regime of corporate governance, requiring corporations, LLCs, and limited partnerships to impose data reporting obligations on their investors and their affiliates. Investors that are not natural persons will need to provide information about their beneficial owners. Beneficial owners who are natural persons will need to disclose their residential address and marital status, among other data points. This new regime will require reporting companies to consider aspects of beneficial ownership that were previously outside the scope of their concern. A beneficial owner’s marital status and whether that beneficial owner lives in a community property state is a key example. Reporting companies and the counsel who advise them should consider community property ownership when analyzing beneficial ownership disclosures.
