The Corporate Transparency Act: Unnecessary and Unconstitutional

Federal courts are often forced to uphold laws as “stupid but constitutional”,[1] as Justice Antonin Scalia remarked, or strike them down as wise but unconstitutional.[2] A recent decision from United States District Court for the Northern District of Alabama applied this dichotomy to the Corporate Transparency Act (“CTA”), declaring it unconstitutional despite its allegedly laudable goals.[3] While Nat’l Small Bus. United v. Yellen struck a blow to the CTA and memorialized what many are thinking—the CTA is a product of serious Congressional overreach—the CTA is far from finished. The decision in Nat’l Small Bus. United applies narrowly and is being appealed. Nonetheless, the case casts an ominous shadow over the CTA and may predict its eventual demise.[4]

The CTA was passed on January 1, 2021, as part of the National Defense Authorization Act.[5] Despite occupying only a handful of pages out of a massive bill, the CTA “packs a significant regulatory punch[.]”[6] Generally, the CTA calls for the disclosure of the identities of tens of millions of individuals, as well as other information, under the threat of prison time and other civil and criminal penalties, solely based on an individual’s status as an “applicant” or “beneficial owner” of a business.[7] Few will argue that the CTA’s goal of preventing money laundering and tax evasion is anything but admirable (although the mechanisms impose an unnecessarily large burden on small businesses and law firms). However, the breadth of the CTA calls into question the law’s constitutionality.[8]

The National Small Business Association, a non-profit that protects the rights of small businesses across the county, spared no time in challenging the questionable constitutionality of the CTA, bringing a lawsuit only six weeks after final rules promulgated to implement the CTA were issued.[9] In its defense, the Government offered three sources of constitutional authority that supposedly gave Congress the power to enact the CTA, all of which were rejected by the Court in Nat’l Small Bus. United: (1) foreign affairs and national security; (2) the commerce clause; and (3) the necessary and proper exercise of Congress’ taxing power.[10]

The Government attempted to assert that, because drug cartels and criminal organizations are often international, its power to govern foreign affairs and protect national security allowed it to pry into the details of every business in America.[11] But the Court rejected this sweeping argument. Noting that business formation has historically been a creature of State, not Federal, power, the Court held that the Government’s foreign affairs powers and national security interests do not extend to “purely internal affairs[.]”[12]

The Government next argued that businesses engage in interstate commerce so the CTA is valid under the Commerce Clause.[13] This too failed, as the Court correctly recognized that the act of forming a business is an isolated act that occurs within a State, not in interstate commerce.[14] Accordingly, the Court held that the Commerce Clause cannot save the CTA because the CTA does not directly regulate commerce, is not limited to acts that impact commerce, and is not part of a comprehensive regulatory scheme.[15]

The Government’s last angle was to claim that the CTA was necessary and proper to “ensure taxable income is appropriately reported,” and thus the CTA was constitutional under Congress’ taxing power and the necessary and proper clause.[16] The Court quickly recognized that CTA penalties, a punitive result of a knowing or willful violation of the law, cannot be viewed as a tax within the scope of Congress’ taxing power.[17] Furthermore, the Court held, the CTA is not necessary and proper for the exercise of the taxing power.[18] The Court discussed the attenuated link between the CTA’s allowance of tax-enforcement officials’ access to CTA data and “necessary and proper” taxation legislation, raising a valid concern.[19] Refusing to approve of such a weak link, the Court remarked that such a theory would result in a “substantial expansion of federal authority” by allowing Congress to enact any law so long as it collects data that might be useful for tax collection purposes.[20]

The final blow to the Government’s arguments dealt, the Court granted summary judgment to the National Small Business Association. While a serious strike against the CTA, this victory was limited: the injunction granted by the Court only applied to the individual plaintiff and to the National Small Business Association and its members.[21]

Indeed, only days after the ruling, FinCEN[22] acknowledged its defeat and confirmed that it would not be enforcing the CTA against the plaintiffs in Nat’l Small Bus. United.[23] However, FinCEN further clarified that it would “continue to implement the Corporate Transparency Act as required by Congress, while complying with the Court’s order” and that it is appealing the decision.[24]

In other words, a limited group of businesses won a reprieve from CTA reporting requirements, but businesses at large must still comply with the CTA or risk FinCEN enforcement actions. Nat’l Small Bus. United, or a case like it, may eventually lead to the complete demise of the CTA and its burdensome requirements. Until that day comes, it is critical, for all businesses, to properly navigate the CTA’s complexities to ensure compliance and avoid the steep penalties associated with CTA violations.

If you have questions about meeting the CTA’s reporting requirements, or are interested in challenging the constitutionality of the CTA, please contact the experienced business and government litigators at Eckland & Blando LLP.