To the Editor:
In a story published this week, Kiarra M. Strocko and Stephanie Soong Johnston discuss some of the pertinent features of the Corporate Transparency Act (CTA), which was enacted as part of the National Defense Authorization Act (H.R. 6395). (Related coverage: p. 1156. See also Robert Goulder, “The Trump Veto That (Almost) Saved Anonymous Shell Companies,” Tax Notes Int’l, Jan. 11, 2021, p. 263.)
The story does reference that the beneficial ownership reporting is apparently triggered only if the legal owner is a state law corporation or state law limited liability company. However, what is not discussed is that the CTA references “indirect” ownership as well as direct ownership of the state law reporting entity, but does not define what indirectly means.
It is also not discussed whether there is reporting if the state law corporation or LLC is part of a tier of entities where the state law corporation or LLC is not the top-tier entity (such as a private equity fund, where the top-tier entity is not uncommonly a state law limited partnership with an S corporation as the general partner to deal with self-employment tax issues of the ultimate owners). For example, what if a state law LLC or corporation is directly owned by a state law limited partnership — is there reporting under the CTA?
The CTA, as noted, does not define indirect ownership. The CTA references beneficial ownership and ownership interest, but does not say whether indirect ownership through a grantor trust, check-the-box disregarded entity, or state law partnership would trigger a reporting obligation if the ultimate owners are individuals.
In an article published in Tax Notes not that long ago (Monte A. Jackel, “Grantor Trust Ownership: What Does It Mean?” Tax Notes Federal, Apr. 13, 2020, p. 269), I pointed out that there has historically been a split of opinion on whether ownership by a grantor trust was to be treated as actual ownership by the grantor of the assets legally owned by the trust or whether the grantor was merely attributed the federal income tax attributes of the trust. The weight of authority discussed there points to treating the grantor as the actual owner, and I stated that that should be the operative rule for all purposes of the Internal Revenue Code.
I think that this should be the rule for CTA purposes as well, and the rule should include check-the-box disregarded entities and qualified subchapter S subsidiaries as well. (Yes, I am aware of the centralized partnership audit rules, which do not treat these entities as being disregarded (reg. section 301.6221(b)-1(b)(3)(ii)), but there are always exceptions, and besides, those regulations are most likely wrong as well on this point.)
Most importantly, I think, the law has historically been unclear as to whether ownership through various corporate, partnership, or trust entities is itself indirect ownership, or alternatively, ownership through those entities is rightfully to be regarded as only constructive ownership, with indirect ownership being limited to nominee or agency relationships. With all the constructive ownership statutes in the Internal Revenue Code, one would think this issue would be clear. It is not.
There was an article dealing expressly with those latter points in Tax Notes several years back (Jackel and Glenn E. Dance, “Indirect Ownership Through A Partnership: What Does It Mean?” Tax Notes, Jan. 1, 1996, p. 91). The basic premise of the article, both then as well as today, is that the tax law has historically treated ownership through either a corporation or a partnership as indirect ownership because the ultimate beneficial owners of the corporation or partnership are the true economic owners.
This is true, as the article states, even though the inclusion of entity ownership through a corporation, partnership, or trust has almost always been included in attribution of ownership statutes — such as sections 267, 544, and 1561 — as constructive ownership. Indirect ownership, it was argued there, should logically be limited to entity ownership as a nominee or agent on behalf of another. Despite this logical position, the IRS has issued a number of revenue rulings throughout the years treating ownership through a corporation or a partnership as indirect ownership under mostly the corporate provisions of the Internal Revenue Code.
Well, if the above indirect ownership principles are true, then interposing a corporation or a partnership in a tier of entities should be treated as if that corporation or partnership did not exist for CTA reporting purposes. The same should hold true for grantor trusts and other disregarded entities.
The one issue the regulations to be issued may not reach may be where a state law corporation or state law LLC is not the top-tier entity in a structure with one or more ultimate individual owners (which must always be the case). But compare that case with the case where the latter entities are second-tier entities. In that scenario, the ultimate owners of those second-tier entities (that is, the direct owners of the top-tier entity) would be subject to CTA reporting.
Can the statute be stretched to reach the cases where the top-tier entity is not a state law corporation or partnership, then? That is unclear, but the wording of the CTA seems to require the top-tier entity to be either a state law corporation or a state law LLC, even though that makes no sense based on the substance of such an arrangement. On the other hand, the various IRS revenue rulings involving corporations and partnerships and indirect ownership seem to favor CTA reporting in those cases as well. We’ll see.