Introduction and Background
Let’s start with a quick refresher to set the stage for an important issue confronting many people who have created trusts. The Corporate Transparency Act (CTA) is a new law that became effective January 1, 2024, for newly formed entities and requires them to file informational reports with the Financial Crimes Enforcement Network (FinCEN). The real kicker begins January 1, 2025, when most entities that existed before 2024 will have to report. The reports are simple but rather personal and invasive, e.g., driver’s license, Social Security Number, home address, etc. The penalties for not filing are onerous, $500/day, and up to two years in jail.
Who May Have To Report For A Trust That Owns an Entity?
Let’s speculate what the penalties might mean. Let’s say you formed an LLC to own investment assets held by three different irrevocable family trusts. The LLC is owned 1/3rd by each trust. Each trust has the following positions filed with people:
1. General trustee.
2. Investment trustee or investment adviser.
3. Distribution trustee or distribution adviser.
4. Trust protector.
5. The person holding the power to loan trust assets to you as the settlor who created the trust.
6. The person who can swap or substitute assets of equivalent value for trust assets.
Let’s say each trust has different people named to keep the trusts independent and to make it more difficult for the IRS or a creditor to argue that the trusts should be aggregated. This division and independence might have been in part used when you made initial gifts to the trust. If each trust received a gift of 1/3rd of an LLC, the value of those LLC interests may have been reduced for gift tax purposes because private interests aren’t marketable and no one could control the entity. For the latter discount, it may have been helpful to have different people named as trustees and in other positions to support the position that each trust lacked control over the entity.
What about beneficiaries? The law seems to indicate that a beneficiary of a trust who is the sole permissible recipient of income and principal of the trust or who can withdraw substantially all of the assets from the trust will be tagged. That means that such a beneficiary would be deemed to own the ownership interest in a Reporting Company held by the trust. But what might that mean? In a typical testamentary marital trust the surviving spouse must be the sole income beneficiary. But that doesn’t mean that the spouse is assuredly a principal beneficiary. That will depend on the terms of the trust. While most marital trusts (e.g., a Qualified Terminable Interest Property or QTIP
TIP
OK, now the CTA appears, and each of the above people, six per trust or 18 in total, may have to file Beneficial Owner information with FinCEN. But that may not be all. Beneficiaries may also have to file as Beneficial Owners. There could be 20 or more people tagged to file under the CTA. Will the $500 penalty apply to all of them? If so, that is $10,000/day!
Can Beneficial Owners in Trusts Be Penalized For Not Cooperating?
It wasn’t clear in the CTA guidance that Beneficial Owners who fail to give a company that has to report under the CTA (called Reporting Companies) their Beneficial Owner Information (BOI). Many people expressed concern about this issue. A company might have to report both its information and information about its beneficial owners, but if the owners or substantial control persons (e.g., a director or manager of an entity) refused to provide information to the company, they would effectively prevent the company from reporting correctly. How could these owners be motivated to comply if they were not penalized? FinCEN appears to have gotten the message and issued a Frequently Asked Question (and answer) at the end of last year to address this: “K. 3. ii. Can a beneficial owner or company applicant be held liable for refusing to provide required information to a reporting company? Yes. As described above, an enforcement action can be brought against an individual who willfully causes a reporting company’s failure to submit complete or updated beneficial ownership information to FinCEN. This would include a beneficial owner or company applicant who willfully fails to provide required information to a reporting company. [Issued December 12, 2023].”
But alas, even though the above might be helpful, getting those involved with trusts to report may still be a messy challenge.
Who Rats on the Recalcitrant Beneficial Owner?
Who can report the uncooperative person to FinCEN? There is no guidance. But it would seem that the company that has to report and face penalties if a Beneficial Owner doesn’t supply the requisite information might be able to inform the Beneficial Owner that if they don’t do what they are required to do in terms of reporting, the company will have to report them to FinCEN. They may be subjected to that $500/day penalty.
Since those in charge of the Reporting Company may face penalties for an incomplete CTA filing by the company, they would certainly have the incentive to rat on the Beneficial Owner not providing data. Before someone involved with an entity snitches on a recalcitrant entity Beneficial Owner carefully review the governing documents for the entity to ensure there are no restrictions on that action.
The situation with a trust that owns interests in an entity and has to report under the CTA can be more sticky. The trustee owes a fiduciary duty, a duty of loyalty, and perhaps a duty of confidentiality to the trust’s beneficiaries and may be prohibited from disclosing confidential information about any beneficiary to FinCEN. So, any trustee seeking to snitch on a Beneficial Owner involved with a trust owning an entity or who even wishes to convey confidential personal information to FinCEN that it already has should review the trust and state law and perhaps even consult with an attorney to see what they can do.
For new trusts and entities, it might (not must, but might) be feasible to add language to the trust or entity governing documents authorizing disclosures and mandating that those who have to report as Beneficial Owners agree to do so. Older trusts and entities that don’t have this language may need legal guidance on what steps they can, or should, take. For new trusts, for example, you might have your lawyer put a place to note the FinCEN Identification Number that a person obtains in their signature block so that the trust gets that number when they sign. The trust might even provide that until that FinCEN Identification Number is obtained and given to the trust that, that person’s appointment is not valid.
Do You Even Know Who Is Appointed in Your Trusts?
Most folks create trusts and, after signing them, ignore their professional adviser’s standard recommendation to come back periodically (every year or so) to review the status of the trust. It is common for people who created trusts long ago to have had no professional guidance after the trust was signed. Many people have not looked at their trusts since they were signed. So, for example, lots of taxpayers created irrevocable trusts in 2012 before the exemption was supposed to drop from $5 million in 2012 to $1 million in 2013. People made gifts to those trusts to lock in that higher exemption. In 2013, the law ended up not changing, but lots of people created those trusts. When was the last time you spoke to the person in charge of making loans to you from your trust? Do you have their current contact information? If you haven’t talked much (or at all!) to that person in over a decade, how do you think the call will go? “Hey Jane, long time no talk. I’m sure you remember that in 2012 I named you in my trust to have the power to loan me money. Because of the CTA we’ll need a copy of your driver’s license, home address and Social Security Number.” That will go over, in many cases, worse than the proverbial lead balloon.
It Could Be Even Worse
Many trusts, perhaps even most, never have had people other than the settlor creating the trust and the trustee signing the trust document. Thus, in many cases, someone named, even long ago, as a trust protector, or to hold a loan power, or a power of appointment (a right in the trust given to a person to designate whom trust assets should be distributed to), and others may not even know that they were named. They may never even have been informed that they held a particular role. Sometimes settlors creating trusts intentionally did not tell people they named because they did not want them to know in case they changed their appointment at a later date.
What Should You Do?
You cannot wait until the end of 2024 to deal with these issues as there will be inadequate time, and likely, professional advisers will be swamped and unable to help you. So it would be best if you were proactive and soon. Review every trust you have. If you have people named you are not in touch with, or they might be hesitant or refuse to take the steps they will be required to take under the CTA, change the appointments now. So, your old college roommate, who was named to hold the power to loan trust assets, might be removed. Depending on the terms of the trust document and state law, it may be possible for the trustee or a trust protector to sign a relatively simple document to remove that person. You might contact that person and ask them to resign. That may not go over well if they were never informed that they were appointed in the first place or if they forgot about it. Alternatively, it may be feasible for the trustee to decant or merge the trust into a new trust that names someone else to that position.
Another approach to consider if you will have to modify the trust via a decanting or some other arrangement might be to choose not to appoint anyone to serve in a particular position presently. Instead, leave it up to the trust protector to appoint a person at a future date if there is a need for someone in that named position to take action. That might avoid the filing.
Evaluate whether all the entities that you have now, and which trusts might own interests in, should be kept. It appears that if an entity is dissolved before it files its first CTA report there will be no beneficial owners at the date a report would be filed, so that there is no reporting. Dissolving unneeded entities is a way to avoid reporting issues they could trigger.
Be Smart
If you are already reviewing all your entities and trusts and relevant documentation, use the CTA pre-filing planning steps as an opportunity to clean up old records, oversights in trust or entity administration, or more. Remember that one of the most common ways the IRS unravels a tax plan, or a creditor reaches through an entity/trust structure, is when the taxpayer or person involved themselves did not adhere to the required formalities.