Tax History: The Trump Veto That (Almost) Saved Anonymous Shell Companies

Presidential vetoes are fairly common, though they seldom carry tax implications. There have been 40 presidential vetoes since the turn of the century. That includes 39 conventional vetoes plus a single pocket veto. If you’re keeping score, the tally is as follows: President Clinton vetoed seven bills during his last year in office; Presidents Bush and Obama each vetoed 12 bills during their terms; and President Trump used the veto power on 10 occasions. Most of the Trump vetoes related to congressional resolutions on arms sales or executive war powers (the latter, as to Yemen and Iran).

For most of his term, none of  Trump’s vetoes had been overridden by Congress — which requires a two-thirds majority in each chamber. That changed on January 1 when the Senate voted to override Trump’s veto of the National Defense Authorization Act (NDAA, H.R. 6395), by a vote of 81 to 13. Days earlier, the House of Representatives similarly voted to override the veto, 322 to 87. Neither of the votes was close, reflecting the NDAA’s broad bipartisan support.

The new law calls for combined federal spending of $741 billion, including pay increases for military personnel. Trump offered several justifications for his veto. He objected to the bill’s renaming of military facilities commemorating Confederate officers. He also complained that the bill failed to eliminate civil liability protections for social media companies concerning content posted by third parties, as provided for under the Communications Decency Act. The second objection strikes me as odd because the NDAA has nothing to do with the aforementioned liability protections. I suspect that Trump couldn’t pass up an opportunity to bash social media platforms. Perhaps there were other unspoken factors behind Trump’s opposition, as we will see.

The tax world cares about the veto, and its subsequent override, for a different reason. The NDAA is composed of eight subparts, one of which is the Corporate Transparency Act, which enhances the country’s anti-money-laundering regime. It introduces significant rules affecting shell companies, which have long been used to facilitate tax evasion. This is good news.

It’s no surprise the Corporate Transparency Act is embraced by nongovernmental organizations like Transparency International. What’s remarkable is that the reforms are also embraced by mainstream corporate interests and their allies, including the U.S. Chamber of Commerce. Even the state of Delaware is on board. It’s worth reviewing how the interests of these diverse parties came to be aligned.⁴

From Mickey Mouse to Stormy Daniels

I’ve never been a big fan of anonymous shell companies, which makes me something of a hypocrite because I always enjoyed Disney World as a child. What’s the connection, you ask? The tracts of land on which Disney World sits were acquired through an assortment of anonymous shell companies. Their use significantly lowered the land acquisition costs. Without them, the entire project might not have been commercially feasible. Had Walt Disney

DIS
 marched into central Florida and let it be known what he was up to, the landowners could have demanded exorbitant prices, because the fortuitous location of their lots caused them to be unique.

The westward expansion of U.S. railroads in the 19th century required eminent domain laws, as did the interstate highway network a century later. Disney World needed shell companies for the same reason. The point being, such entities can have legitimate uses beyond drug trafficking and terrorist financing. Many small business owners use shell companies, hoping their use may conceal private wealth from business creditors — or from ex-spouses in the event of divorce. That might be sneaky, but it’s not illegal. The objective in regulating these entities is to prevent the associated illicit activities, while not prohibiting the entities’ existence altogether.

How prevalent are illicit activities? It’s hard to say, because we only learn about them when the scams break down in a public unraveling. Anecdotal evidence suggests bad actors, both foreign and domestic, made frequent use of U.S.-based shell companies. Convicted Russian arms dealer Viktor Bout used 12 shell companies (based in Delaware, Florida, and Texas) to help conceal his sale of weapons, worth millions of dollars, to terrorist organizations. Bout’s story served as the basis for the 2005 film Lord of War, starring Nicolas Cage.

Corrupt foreign officials have done similar things. Equatorial Guinea’s President Teodoro Obiang has been described as Africa’s worst dictator, and that was while Zimbabwe’s former prime minister and president, Robert Mugabe, was still alive. Obiang, who is effectively president for life, used U.S. shell companies to siphon off an estimated $100 million in public funds, robbing his own country blind. Among other things, his family used the slush fund to acquire a $33 million private jet, a $35 million property in Malibu, California, and the iconic crystal-embedded glitter glove once worn by Michael Jackson. Because of the efforts of U.S. prosecutors, Obiang’s family was eventually forced to forfeit the private jet and the Malibu estate . . . but not the glitter glove.

The cryptic use of domestic shell companies has been in the news for other reasons as well. During his congressional testimony, disbarred attorney Michael Cohen, Trump’s former lawyer, bragged about how it took him only a few days to create and fund the Delaware shell company used to distribute hush money to adult film personality Stormy Daniels. The transaction allegedly violated campaign finance laws by improperly characterizing the payment as a legal expense. It remains the subject of scrutiny by New York prosecutors seeking Trump’s tax returns as part of their grand jury proceedings. We would be remiss if we failed to mention that Cohen has pleaded guilty to several offenses including tax evasion, bank fraud, and lying to a Senate committee.

You get the point: People can use shell companies for bad things. The challenge for the Corporate Transparency Act’s drafters was to require disclosure for the nefarious purposes, while allowing degrees of opacity for more mundane matters.

Hypothetically speaking, if you were a person who used anonymous shell companies to break the law — say, by violating campaign financing laws — you might have your own personal reasons for blocking enactment of the NDAA. Of course, that’s just speculation.

Enter FinCEN

The Corporate Transparency Act requires that corporations, limited liability companies, and other entities established under state law disclose their beneficial owners to the Treasury Department — specifically, to the Financial Crimes Enforcement Network, known as FinCEN. That’s the same Treasury unit that handles foreign bank account reporting standards (FBAR Form 114), familiar to U.S. taxpayers living overseas.

The requirement applies to newly formed entities as well as those established before enactment. Preexisting entities have a two-year grace period to bring themselves into compliance, unless ownership changes during the grace period in which case the entity must comply immediately. Failure to do so can result in both civil and criminal penalties, with fines of $10,000 and prison terms of up to 24 months. The liability extends beyond the beneficial owners themselves. Clark Gascoigne of the Financial Accountability and Corporate Transparency Coalition notes the penalties could apply to lawyers, accountants, real estate agents, or anyone else who acts as a corporate formation agent.

The required information includes the owner’s name, address, date of birth, and a suitable identification number, for example from a state-issued driver’s license or a U.S. passport. The information provided must be updated if there are any changes in an entity’s beneficial ownership. You can’t thwart the disclosure requirements by simply transferring ownership after the fact. The resulting FinCEN registry is likely to become quite large over time. About 2 million corporations and LLCs are formed each year at the state level.

The penalties under the Corporate Transparency Act target individuals who knowingly provided false or incomplete information to FinCEN. Unintentional noncompliance is excused. The distinction is bound to open a can of worms. The FBAR compliance area already struggles with the nuanced meaning of what constitutes a “willful” violation, as opposed to one that is merely “reckless.” To the frustration of taxpayers, the government’s interpretation of willfulness can resemble a strict liability standard, arguably not what Congress intended for the FBAR regime. Depending on how prevalent the related penalties become in the years ahead, we might well see a parallel line of controversies play out in the courts.

If you can readily distinguish between willful dishonesty and reckless dishonesty, then you possess a better eye than me. With a willfulness standard, the Corporate Transparency Act is setting us up for years of awkward litigation over FinCEN penalties. Without a willfulness standard, the act never gets passed. That’s what progress looks like.

Impossible Is Nothing

The success of the act is a story of patience and compromise. One key to forging this alliance is the idea that access to the resulting FinCEN database will be limited, for example, to law enforcement. The assembled information on beneficial ownership will not be open to public inspection, though each state can choose to make its own records public. Transparency advocates would have preferred to see the database available for public scrutiny, but that would have killed off any hope for bipartisan support.

Another key to the act’s appeal is that it is based around a single registry of beneficial ownership maintained at the federal level, rather than a disjointed array of state registries. Not only is a single registry easier to search, but it offers a blanket solution that puts all states on equal footing for purposes of federal compliance obligations. The states themselves didn’t want to be responsible for the registry.¹¹ The act of issuing certificates of incorporation is an administrative chore, whereas the building and safeguarding of a registry of this type is a fundamentally different task. By placing the heavy lifting on FinCEN, the act makes things simple for the states.

This feature was noted by Jeffrey W. Bullock, Delaware secretary of state, in his congressional correspondence voicing support for a previous version of the act. Bullock wrote that Delaware had “long argued a piecemeal, state-based approach to the collection of beneficial ownership information would create loopholes vulnerable to exploitation by bad actors.”

An uncoordinated patchwork regime could also trigger a race to the bottom in terms of transparency. That could describe the status quo ante. Some U.S. states — most notably Delaware, Nevada, and Wyoming — are especially popular for those seeking to conceal beneficial ownership, whatever the reason. That makes Delaware’s open support for the act all the more interesting.

The scope of the Corporate Transparency Act has a notable exclusion that lets some types of entities off the hook. Some domestic investment funds, for example, aren’t subject to the disclosure requirements. The exception depends on the fund being advised and operated by a registered investment adviser. That was a practical accommodation to private equity and hedge funds. Otherwise, the act would never have gotten off the ground. There’s no point in making foes of Wall Street if you don’t have to.

You might think that financial institutions as a whole would oppose the act, but not so. Banks welcomed enactment because of how it will help them satisfy obligations under the Bank Secrecy Act. The Corporate Transparency Act permits the compliance departments of U.S. banks to directly access the FinCEN database to perform their necessary background checks on account holders. That convenience is no small thing. It managed to flip the banking lobby from opponent to enthusiastic supporter.

Time will tell whether the Corporate Transparency Act improves how the United States is perceived internationally. The Tax Justice Network ranked the United States as the world’s second-worst tax haven, just behind the Cayman Islands. The dismal position was largely because of U.S. states’ failure to require beneficial ownership disclosures. That deficiency has now been cured.