What Franchisors and Franchisees Need to Know About the Corporate Transparency Act | Polsinelli

What Franchisors and Franchisees Need to Know About the Corporate Transparency Act | Polsinelli

A federal law requires franchisor and franchisee business entities to disclose personal information and photographs of the individuals who own and control their business.

Why this is important to you. From Wall Street to Main Street to your street, the vast majority of private entities and many nonprofits have been forced to comply with the Corporate Transparency Act (CTA). If you own or control a franchised business, or are a franchisor, you need to pay attention. Not only is initial reporting important, but so is ongoing compliance and coordination with other disclosures you currently make.

What is this law about? If you’ve never heard of the CTA, you’re not alone. Many business owners, executives, and professional advisors are surprised to learn of the existence and scope of the CTA. At its core, the CTA requires the reporting of direct and indirect personal information about the beneficial ownership and control of businesses operating in the United States. Personally identifiable information (PII) includes name, date of birth, physical home address, and your photo. The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has established a Beneficial Ownership Secure System (BOSS) to receive, store, and manage this vast influx of information. FinCEN estimates that more than 32 million existing businesses will be required to report their activities this year alone. This law aims to prevent money laundering, illicit financial activities, corrupt practices and the financing of terrorism, to the detriment of many legitimate businesses (and their owners and controlling persons) who are swept away by these new, expanded reporting requirements.

Who should report? Personally identifiable information must be reported for individuals who own, directly or indirectly, 25% or more of a class or category of economic interest in a business entity, or who have or may exercise, directly or indirectly, “substantial control” over a business entity. Both of these factors are nuanced and will require the exercise of business judgment to assess their implications for a particular business entity.

Franchisors should note that certain attributes of control in their agreements with franchisees may attribute “substantial control” of a franchisee’s business to the franchisor and its controlling persons, requiring disclosure of the personal information of such franchisor persons in their franchisees’ CTA reports. This may be particularly true in light of the National Labor Relations Board’s recent expansion of the definition of “joint employer” as it may apply to certain franchise agreements.

What is the continuous reporting obligation? Once the initial report is filed, this information must be updated within 30 days of any subsequent event that renders the previously reported information inaccurate. The attribution of ownership and what constitutes substantial control will vary from company to company and will require professional analysis and advice.

Exempt entities. Certain categories of business entities are exempt from CTA compliance. These typically include regulated business entities, such as publicly traded companies, insurance companies, banking companies, 501(c) nonprofit entities that are exempt from federal tax, and governmental and quasi-governmental organizations. There are two other exemptions that are particularly important to the franchise industry:

Exemption for large operational entities

In addition to the other exemption categories, a general exemption is available to any business entity that meets the following three thresholds: (1) operates from a physical business address in the United States, (2) has 21 or more full-time U.S. employees, and (3) generates more than $5 million in annual gross receipts in the United States, as reported on the business entity’s prior year federal tax return. Failure to meet any of these criteria will render a business entity ineligible for this exemption. A key element of this exemption is that only full-time W-2 employees of the entity itself are eligible.

Many franchise businesses use part-time employees, subcontracted employees, seasonal employees, independent contractors, and other arrangements that could impede an entity’s ability to reach and maintain a workforce of 21 or more full-time employees throughout the year. In addition, FinCEN has declined to allow businesses to consolidate the workforce of affiliated business entities.

Exemption for wholly-owned subsidiaries of exempt entities

The CTA also contains an exemption for a wholly-owned subsidiary of exempt entities. For example, if a parent company is a large operating entity and wholly owns a subsidiary, the subsidiary would also be exempt from reporting to the CTA. However, this exemption only applies to subsidiaries that are wholly-owned by one or more CTA-exempt entities. For businesses with large and complex organizational structures, it is important to analyze each entity individually, as joint ventures would not qualify for this exemption (unless all owners are CTA-exempt entities). This exemption also does not apply to upstream entities, meaning that a parent company that is not exempt would not qualify for the exemption because of its investment in an exempt subsidiary.

What will compliance look like? Businesses will be required to compile, maintain, and continually update their reported personal information to meet CTA compliance requirements. Any changes or corrections to previously reported information must be made within 30 days of the event, not when the business becomes aware of it. All newly formed business entities in 2024 will be required to file their initial report with the CTA within 90 calendar days of their formation. 1 Reporting businesses that existed before 1 January 2024 will have until 1 January 2025 to file their initial return with the ACT.

What happens if you don’t comply? Fines are steep ($500 per day up to $10,000 per incident).2 and possible prison time (up to two years) for those who fail to properly and timely comply with the CTA. In addition, the IRS recently announced enhanced enforcement, with plans to use new data analytics technology to identify audit targets. The FinCEN database has been identified by the IRS as a key component of this data analytics initiative.

Who can access FinCEN’s Beneficial Ownership Secure System (BOSS)? The information contained in BOSS will be accessible to law enforcement at the federal, state, and local levels. Financial institutions may also have access to it with their customers’ consent. As such, CTA disclosures are expected to become a key component of regulatory and corporate due diligence for future transactions. It is important to note that this reported information is not publicly available and is not accessible through Freedom of Information Act (FOIA) requests.

Conclusion. If you own a business, you now have compliance obligations under the CTA. Now is the time to discuss the CTA with our legal team for advice.