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Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 8 offices, was ranked number 1 in the category “Most innovative North American law firms: New working models” by The Financial Times and was 1 of 7 firms shortlisted for The American Lawyer’s inaugural Legal Services Innovation Award. The firm has been recognized by the National Law Journal as a Legal Technology Trailblazer and featured by Bloomberg for its innovative service delivery models, which drive accuracy and predictability. The firm’s commitment to innovation is embodied in Thompson Hine SmartPaTHTM – a smarter way to work – predictable, efficient and aligned with client goals. For more information, please visit ThompsonHine.com and ThompsonHine.com/SmartPaTH.

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The Corporate Transparency Act (CTA), enacted in 2021, aims to enhance transparency in entity structures and ownership to combat money laundering, tax fraud, and other illicit activities. It requires certain business entities to disclose information about their beneficial owners, helping law enforcement detect and prevent misconduct through business entities. Beneficial ownership reporting requirements to the Financial Crimes Enforcement Network of the Department of the Treasury (FinCEN) under the CTA became effective January 1, 2024. For entities formed before January 1, 2024 that are not otherwise exempt from the CTA, beneficial ownership reporting is due on January 1, 2025.<a href="#_ftn1">[1]</a> For entities formed between January 1, 2024 and December 31, 2024 that are not otherwise exempt from the CTA, beneficial ownership reporting is due within 90 days of formation.<a id="_ftnref2" href="#_ftn2">[2]</a> For entities formed January 1, 2025 or later, beneficial ownership reporting is due within 30 days of formation.<a id="_ftnref3" href="#_ftn3">[3]</a> While many entities will fall under exemptions from reporting, we anticipate that many ESOP-owned corporations will not. Thus, ESOP-owned corporations should evaluate whether they are subject to the reporting requirement to FinCEN under the CTA.

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What is an ESOP and how may the corporate structure of an ESOP-owned entity be unique?

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An employee stock ownership plan (ESOP) is a company-paid retirement benefit that primarily invests in stock of the employer. An ESOP is designed to primarily hold corporate stock, so an ESOP-owned company must be a corporation (as opposed to a limited liability company, for example).<a href="#_ftn4" id="_ftnref4">[4]</a> You might hear ESOP-owned corporations referred to as “employee owned”; however, the actual shareholder of an ESOP-owned corporation is the ESOP Trust, which holds the shares of the corporation on behalf of the plan participants. Many entities desiring to sell to an ESOP put in place a holding company structure prior to selling to an ESOP. This may be because, for example, (i) the entity was initially formed as a limited liability company (which may not be owned by an ESOP), or (ii) as a part of the ESOP transaction, several entities with commonality of ownership were brought under one holding corporation so that the entire business could be sold to the ESOP. Alternatively, many ESOP-owned corporations move to a holding company structure to facilitate acquisitions following the formation of the ESOP.

What about the ESOP holding company structure could make an ESOP-owned corporation ineligible for CTA exemptions?

There are several exemptions to CTA reporting obligations, and this article does not attempt to summarize all of them. However, an exemption that may be very common among privately owned companies is the large operating company exemption. If an entity meets all of the following criteria, it will be exempt from CTA reporting obligations: (a) employs more than 20 employees on a full-time basis in the United States, (b) filed in the previous year a federal income tax return in the United States demonstrating more than $5 million in gross receipts or sales, including gross receipts and sales of entities owned by the entity, and (c) has an operating presence at a physical office in the United States.<a id="_ftnref5" href="#_ftn5">[5]</a> Because ESOP-owned corporations have a holding company structure where the entity directly owned by the ESOP houses nothing other than sponsorship of the ESOP, many will not meet this exemption, for example, if the holding company does not have at least 20 employees.

If determined to be ineligible for an exemption, how should an ESOP-owned corporation report beneficial ownership?

If no other exemption applies, then the ESOP-owned corporation will be required to report beneficial ownership (among other items) to FinCEN. Beneficial ownership analysis for purposes of the CTA must be conducted on a case-by-case basis, and this article only attempts to provide some key considerations specific to ESOP-owned holding corporations. A beneficial owner is an individual who exercises substantial control over the entity (which includes CEO, president, CFO, COO, general counsel, and others performing similar functions regardless of title and members of the board of directors) or owns or controls 25% or more of the ownership interest of the entity (including warrants).<a href="#_ftn6" id="_ftnref6">[6]</a>

For corporations that are owned 25% or more by an ESOP, the trustee of the ESOP Trust is likely a beneficial owner for CTA reporting purposes. Issuance of interest-replacement warrants to selling shareholders in the sale of shares to an ESOP is very common, and such selling shareholders may also be considered beneficial owners if they were issued more than 25% of the fully diluted equity of the entity in the form of warrants, and such selling shareholders should consider allocation of shares to their participant accounts in the ESOP as well. Unless there are very few employees of the participating employers in the ESOP, it is unlikely that any individual plan participant would own more than 25% of the allocated shares of an ESOP solely through the plan, so it’s probable that individual ESOP participants are not subject to beneficial ownership reporting (unless they exert control over the entity in some other way, such as holding an officer or director position or if they hold warrants or some other ownership interest in the entity). With respect to each beneficial owner, the corporation must report the name, date of birth, address, and unique identifying number from an acceptable document (e.g., driver’s license) or such beneficial owner’s unique FinCEN identification number.<a id="_ftnref7" href="#_ftn7">[7]</a>

The above are only the initial, high-level questions to consider regarding CTA compliance for ESOP-owned corporations, and ESOP-owned corporations should reach out to legal counsel for guidance on beneficial ownership analysis based on their particular circumstances. For more information about the Corporate Transparency Act generally, see “<a href="https://www.thompsonhine.com/insights/federal-corporate-transparency-act-takes-effect-january-1-some-states-following-suit/">Federal Corporate Transparency Act Takes Effect January 1; Some States Following Suit</a>.” Visit our website for more information about our <a href="https://www.thompsonhine.com/services/employee-benefits-executive-compensation/esop-services/">ESOP Services</a>.

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<a href="#_ftnref2" id="_ftn2">[2]</a> 31 CFR § 1010.380(a)(1)(i)(A).

<a href="#_ftnref3" id="_ftn3">[3]</a> 31 CFR § 1010.380(a)(1)(i)(B).

<a href="#_ftnref4" id="_ftn4">[4]</a> 26 U.S. Code <a>§</a> 409(l)(1).

<a href="#_ftnref5" id="_ftn5">[5]</a> 31 CFR § 1010.380(c)(2)(xxi).

<a href="#_ftnref6" id="_ftn6">[6]</a> 31 CFR § 1010.380(d).

<a id="_ftn7" href="#_ftnref7">[7]</a> 31 CFR § 1010.380(b).

https://admin.thompsonhine.com/wp-content/uploads/2024/03/Business-Law-Update-March-2024.pdf

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<em>This client update may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgement of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.</em>

<em>This document may be considered attorney advertising in some jurisdictions.</em>

Corporate Transparency Act Compliance for Employee Stock Ownership Plans

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