Why Small Businesses Cheer as Judge Strikes Down ‘Transparency’ Law

Lawmakers snuck the Corporate Transparency Act into the 1,480-page National Defense Authorization Act in 2021.

The measure is targeted squarely at small businesses with fewer than 20 employees or $5 million or less in gross receipts. Companies larger than this are exempt.

The Corporate Transparency Act also exempts companies in many lines of business (banks, broker-dealers, utilities, accounting firms) that are vastly more able to abuse the financial system than are the targeted Main Street businesses. It affects approximately 11 million small businesses and will impose costs exceeding $1 billion annually.

The Corporate Transparency Act requires these businesses to report their beneficial ownership to the Financial Crimes Enforcement Network at the Treasury Department.

A serious problem, however, is that the law doesn’t define ownership as actual ownership but as including anyone who exercises “substantial control” over a business. The problem is compounded by the fact that the financial crimes unit’s regulations morphed this requirement into a test of “substantial influence over important matters.”  

So, in principle, this regulation requires the smallest companies in America to report just about anyone who works for them as a beneficial owner, potentially excluding the janitor. Business owners who get this wrong are subject to fines of up to $500 each day that the violation continues or hasn’t been remedied, as well as up to two years in prison.

All of this is particularly outrageous because better information about ownership is already on Treasury Department computers at the Internal Revenue Service. This information is provided on IRS forms SS-4, K-1s, 1099-DIV, and 8822-B. Instead of turning millions of small business owners into potential felons and imposing massive costs on struggling small businesses, all Congress needed to do was to have the IRS send existing ownership information to Treasury’s Financial Crimes Enforcement Network.

That, however, would have required the House Financial Services Committee to work with the House Ways and Means Committee and the Senate Banking Committee to work with the Senate Finance Committee. And that did not happen.

Judge Liles C. Burke of the U.S. District Court for the Northern District of Alabama, ruling March 1 in the case of NSBA v. Yellen, held that the Corporate Transparency Act is unconstitutional “because it cannot be justified as an exercise of Congress’ enumerated powers.”

“This conclusion makes it unnecessary to decide whether the CTA violates the First, Fourth, and Fifth Amendments,” Burke ruled, referring to amendments to the Constitution.

This is certainly good news for small businesses and for those concerned about financial privacy in the United States. But it is only the first step in what will be a long process.

The federal government has filed a notice of appeal and declared that it will effectively ignore the holding of the District Court. The appeal will be heard in the U.S. Court of Appeals for the 11th Circuit.

The Financial Crimes Enforcement Network, or FinCEN, has stated that “reporting companies are still required to comply with the law and file beneficial ownership reports as provided in FinCEN’s regulations” unless they are members of the National Small Business Association.

While the result of the District Court case is welcome, the reasoning of the decision is notable. The judge found that the Corporate Transparency Act was beyond Congress’ enumerated powers and specifically found that neither the Constitution’s commerce, taxing, and necessary and proper clauses, nor Congress’ foreign affairs and national security power, provide the authority to enact this law.

The District Court didn’t use the Bill of Rights to strike down the law, however. This is very unusual and makes this a potentially important case.

If the lower court’s decision in NSBA v. Yellen is upheld, we can hope that it would lead to some narrowing of the scope of federal power under a 1942 Supreme Court case.

In Wickard v. Filburn, the high court held that a farmer’s growing grain to feed his own pigs, which would be eaten by his own family, affected interstate commerce and therefore was subject to federal regulation.

And if the ruling is upheld, this also would be among a short list of cases that stand for the proposition that meaningful boundaries limit the federal government’s ability to regulate under the commerce clause.

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