On March 1, 2024, in National Small Business United v. Yellen, the U.S. District Court for the Northern District of Alabama held Congress exceeded its constitutional authority by enacting the Corporate Transparency Act (“CTA”). This article discusses the decision and its implications.

Background

The CTA, which went into effect on January 1, 2024, is designed to limit money laundering and other fraudulent acts by requiring certain entities to disclose their beneficial owners to the United States Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”).Generally, any entity created through a filing with a Secretary of State must report its beneficial owners; however, there are 23 exemptions to these reporting requirements, largely consisting of heavily regulated industries and large operating companies. In short, “beneficial owners” either (1) own or control at least 25% of the ownership interests of the company; or (2) exercise “substantial control” over the company.

Companies formed before January 1, 2024 must file their initial reports by January 1, 2025. Companies formed during 2024 have 90 days to file their initial reports. Lastly, companies formed in 2025 or later will have 30 days from the date of confirmation of formation to file their initial reports. If any of the information in the initial report changes, the entity must file an updated report within 30 days of the change(s). For a more detailed explanation of the CTA, see The Corporate Transparency Act: What You Need to Know, an article by Kristi O’Brien and Mitch Wallum.

The Court’s Opinion

The plaintiffs, National Small Business United dba National Small Business Association (“NSBA”) and Isaac Winkles, an NSBA member, argued that Congress exceeded its constitutional powers by enacting the CTA. The defendants, Janet Yellen (Secretary of the Treasury) and Himamauli Das (FinCEN’s Acting Director), argued that Congress had the authority to enact the CTA under (1) its foreign affairs powers; (2) its taxing powers; and (3) the Commerce Clause. The U.S. District Court for the Northern District of Alabama rejected all three arguments, and ruled in favor of the plaintiffs.

Regarding foreign affairs powers, the defendants argued the CTA is necessary to protect U.S. national security interests. They cited Article I’s Necessary and Proper Clause which gives Congress the power to enact laws necessary and proper for carrying out its enumerated powers (including foreign affairs powers). The court rejected this argument by repeatedly emphasizing that incorporation is an internal affair. It added that the Necessary and Proper Clause cannot be used to regulate purely internal affairs even if foreign actors participate in those internal affairs to detrimental effects.

The defendants also argued that, under the Necessary and Proper Clause, collecting beneficial ownership information is necessary and proper to ensure taxable income is correctly reported. The court rejected this argument, concluding that the connection between the Necessary and Proper Clause and Congress’ taxing powers was weak. Similarly to the foreign affairs argument, the court emphasized that upholding the CTA would expand Congress’ authority to enact laws beyond its enumerated powers.

Finally, the defendants argued the CTA is constitutional under the Commerce Clause, which allows Congress to enact laws that either (1) regulate the channels and instrumentalities of interstate commerce or (2) have a substantial effect on interstate commerce. The court disagreed with the first argument, emphasizing that the CTA regulates all entities regardless of whether they utilize the channels and instrumentalities of interstate commerce. Regarding the substantial effect argument, the court held that while the subsequent acts of entities affect interstate commerce, the CTA merely regulates entity formation, which is an act internal to a single state.

The court determined the aforementioned reasons sufficient to rule the CTA unconstitutional, and therefore did not address the plaintiffs’ more peripheral arguments that the CTA violated the First, Fourth, and Fifth Amendments. Case No. 5:22-cv-1448-LCB.

Implications of National Small Business United v. Yellen

While the court did rule that Congress exceeded its constitutional authority by enacting the CTA, the impact of this ruling, at least for now, is limited to the plaintiffs. This means that FinCEN will not enforce the CTA against the NSBA and NSBA members (who were members as of March 1, 2024), as well as Isaac Winkles and his companies. Thus, persons who were members of NSBA on or before March 1, 2024 need not comply with the CTA for the time being. However, all other non-exempt entities still must file the required reports under the CTA.

Additionally, the U.S. Justice Department, on behalf of the Department of Treasury, filed a Notice of Appeal on March 11, 2024. Therefore, the court’s ruling may be overturned. It is unclear when the appeal will be heard. Accordingly, all entities and business owners—regardless of NSBA membership—should continue to monitor these developments.

If you have any questions about this ruling or the CTA more generally, contact Kristi O’Brien, Nate Somers, Mitch Wallum, or one of the firm’s other business attorneys.