Introduction to the Corporate Transparency Act

On January 1, 2024, the new federal Corporate Transparency Act will require the vast majority of small U.S. entities to start filing an online report with the Financial Crimes Enforcement Network (FinCEN) and report beneficial ownership. Existing entities will have until January 1, 2025 to file this report, but entities formed in the new year will need to file within 30 days of formation. Reports with FinCEN are already required for, among other things, foreign accounts, which I discussed in a previous post. However, the CTA is a big deal and represents a complete upheaval of current entity formation and maintenance practice. A number of exceptions to the reporting requirements apply, but generally only include large entities or entities that are otherwise subject to an existing regulatory regime, such as financial institutions. In other words, it is small entities that are being targeted by the CTA, and ultimate individual beneficial ownership is the primary reporting objective.

The reporting requirement is imposed upon the "reporting company" itself, which is any entity formed by filing a document with a state agency. This means that most trusts will not themselves be reporting companies but will likely have complex requirements to provide information about various trust participants if the trust owns a reporting company interest. "Senior officers" of a reporting company are liable for penalties of up to $500 for each day that the violation continues, imprisonment for up to two years, and/or a fine of up to $10,000. Beneficial owners of a reporting company that provide false information or refuse to provide information to the reporting company can also face penalties. A beneficial owner is any individual who exercises "substantial control" over a reporting company or owns or controls at least 25 percent of the ownership interests of the reporting company.

The key pieces of information required of beneficial owners include full legal name, date of birth, physical home address (P.O. Boxes are not allowed), and a copy of the individual's driver's license or passport. If any of this information changes, the reporting company must file a change report. Much of the burden of reporting and keeping track of a beneficial owner's change of information appears to be relieved in large part if the beneficial owner obtains his or her own FinCEN identification number and the reporting company reports that number. Given the detailed personal information that is required to be disclosed and the substantial penalties for noncompliance, we will be hearing much more about the CTA at the start of the new year.

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The Uniform Transfer on Death Security Registration Act

In a prior post, I discussed the trend in probate law whereby nontestamentary arrangements are increasingly favored as ways to transfer property upon death without the need for probate. One such arrangement that I have written about previously is the Uniform Real Property Transfer on Death Act. Another such arrangement is the Uniform Transfer on Death Security Registration Act.

The purpose of the UTODSRA is "to allow the owner of securities to register the title in transfer-on-death (TOD) form," thus providing for a non-probate mechanism for transferring a security upon the death of the owner. Under the act, one or more individuals who own a security can take ownership in "beneficiary form," which simply means that ownership reflects the name of the registered owner(s), followed by the words “transfer on death”, “TOD”, “pay on death”, or “POD,” followed by the name of the beneficiary.

The UTODSRA extends to interests in private companies, including limited liability companies. This can be very beneficial because it is often families of small business owners that have the greatest need for a simple, low-cost alternative to probate.

Many buy-sell agreements restrict ownership of a business to a small group of individuals and provide for the buy-out of an owner upon death. However, depending on the terms of the buy-sell agreement and the owner's individual estate plan, the successor of a deceased business owner may need to go through probate in order to give the manager of the business assurance that the proceeds of the interest buy-out are paid to the right person. The UTODSRA provides one option for streamlining the effectuation of a buy-sell agreement upon the death of a business owner.

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SBA Loans for Small Businesses Impacted by COVID-19

According to the Small Business Administration, small business owners "in all U.S. states and territories" are currently eligible to apply for a low-interest rate loan if the business has suffered substantial economic injury due to coronavirus.

These loans are available through the SBA’s Economic Injury Disaster Loan Program. The loan amount can be for up to $2 million at a 3.75% interest rate for businesses and 2.75% for nonprofits with a term of up to 30 years, depending on the borrower’s ability to repay. These loans can be used to pay for debts, payroll, accounts payable, and other bills that can’t be paid because of coronavirus. Detailed information and online application forms are available on the SBA's website.

UPDATE: Since I published this post, information about the CARES Act has become available. Among other things, this act creates a new "Paycheck Protection Program," which authorizes forgivable SBA loans to eligible businesses. More information is located at this link.

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Covenants Not to Compete

A covenant not to compete is an agreement between an employer and an employee whereby the employee agrees not to engage in a business similar to the employer's business, thereby competing with the employer's business. Under common law in Utah, such covenants are not enforceable unless they are "supported by consideration, negotiated in good faith, necessary to protect a company's good will, and reasonably limited in time and geographic area." TruGreen Companies, L.L.C. v. Mower Brothers, Inc., 199 P.3d 929 (2008).

Until 2016, Utah had no statute governing the enforceability of covenants not to compete. However, the Post-Employment Restrictions Act now voids any covenant not to compete entered into on or after May 10, 2016 that lasts more than one year from the date on which employment ends. This restriction supplements any additional restrictions provided for by common law. This one-year maximum does not apply to nonsolicitation, nondisclosure, or confidentiality agreements; it also does not prohibit severance agreements or business sale agreements which include covenants not to compete.

Importantly, the current law provides an award of arbitration and court costs, attorney fees, and actual damages for an employee if an employer has sought to enforce a covenant not to compete that is found to be unenforceable. Proposed legislation would further protect employees by voiding covenants not to compete that are signed in exchange for mere continuation of employment at the same position and pay level. This proposed law would also void covenants not to compete if an employer fires the employee without cause within six months of the employee's signing the covenant not to compete.

Covenants not to compete can protect an employer's legitimate business interests and should be considered anytime an employee is hired. It is also critical to consider whether an existing covenant not to compete will restrict someone desiring to start a new business. In summary, these contracts are important throughout the entire life cycle of any business.

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The Basics of the Tax Consequences of a Business Asset Sale

The sale of a business by a seller to a purchaser generally can take two forms: A sale of the business’s assets or a sale of equity interests in the business. As a general rule, the seller will favor a sale of equity and the purchaser will favor an asset sale. This is because with an equity sale, the seller will have capital gain whereas with an asset sale, the seller generally has some ordinary income. An asset purchase is more appealing to the purchaser because the tax basis of the assets will be equal to their purchase price and can be depreciated on that basis. The sale of a business via an asset sale is treated as if each of the assets of the business were sold separately for purposes of determining gain or loss.

All assets sold in an asset sale must be classified as capital assets, depreciable property used in the business, real property used in the business, or property held for sale to customers, such as inventory or stock in trade. The gain or loss on each asset is figured separately. The sale of capital assets results in capital gain or loss whereas the sale of real property or depreciable property used in the business and held longer than one year results in gain or loss under IRC § 1231. The sale of inventory results in ordinary income or loss to the seller.

In general, both the purchaser and seller of a business must use the “residual method” to allocate the consideration to each business asset transferred. The purchaser’s consideration is the cost of the assets acquired. The seller’s consideration is the amount realized (money plus the fair market value of property received) from the sale of assets. The residual method determines gain or loss from the transfer of each asset and how much of the consideration is for goodwill and certain other intangible property. It also determines the purchaser’s basis in the business assets.

The residual method requires the consideration to be reduced first by the cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposits) and allocated among the various business assets in the following order:

Class I: Cash, demand deposits, and similar cash items.
Class II: Readily marketable stock and securities and certificates of deposit.
Class III: All other tangible and intangible assets not in any other class.
Class IV: IRC § 197 intangibles other than goodwill and going concern value.
Class V: Goodwill and going concern value.

In this way, gain and/or loss is allocated among all the assets of the business.

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