On March 1, 2024, Judge Liles Burke in the Northern District of Alabama held in National Small Business United v. Yellen that the Corporate Transparency Act (CTA)—enacted by Congress as a 21-page part of the 500-page 2021 National Defense Authorization Act—was unconstitutional. He concluded that the Act “exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’s policy goals.” In so doing, Judge Burke rejected the government’s reliance on its foreign affairs and national security powers, the Commerce Clause, and its tax powers.

The CTA requires the “beneficial owner” of some 32.6 million corporations to provide personal information to the Financial Crimes Enforcement Network (FinCEN). Regulations define “beneficial owner” broadly, so it is not necessarily just one person. The penalties for knowing or willful violations of the Act’s reporting requirements are serious and include civil penalties, fines, and potential imprisonment.

National Small Business United and the owner of two small businesses filed suit contending that the CTA was unconstitutional. In addition to attacking the constitutionality of the CTA, they asserted that its provisions violate the First, Fourth, and Fifth Amendments to the U.S. Constitution. The court first held that the business owner had standing “because the compelled disclosure of [his] sensitive personal information to FinCEN is a concrete, imminent event that is traceable to the government, and redressable by a favorable decision.” It rejected the government’s contention that, because some of the information had been otherwise disclosed, there was no injury, noting that the “disclosure [is] to FinCEN, the Treasury Department’s criminal enforcement division . . . for law-enforcement purposes.” The small business owner’s membership in National Small Business United gave the group associational standing.

The government’s foreign affairs and national security powers are essentially inherent, although unenumerated. The court observed that the act of incorporation is a matter of state law, and that prior efforts to create a federal incorporation mechanism have repeatedly failed. Moreover, given the Supreme Court’s decision in Bond v. United States, holding that the Chemical Weapons Treaty did not “reach purely local crimes,” there was no reason to extend Congress’s inherent powers over foreign affairs and national security to a local matter like incorporation.

As for the Commerce Clause, the court noted, “The plain text of the CTA does not regulate the channels and instrumentalities of commerce, let alone commercial or economic activity.” Indeed, “[t]he word ‘commerce,’ or references to any channel or instrumentality of commerce, nowhere appear in the CTA.” Not only that, but the CTA includes no limitation that might restrict its application to activities that involve commerce or to illegal uses of the corporate form.

The court rejected the government’s reliance on California Bankers Association v. Schultz and American Power & Light Co. v. SEC, stating that “the government reads those cases too broadly.”

Schultz, in which the Court rejected a challenge to the Bank Secrecy Act’s reporting and record keeping requirements, addressed “negotiable instruments and money actually moving in foreign and interstate commerce.” But the court noted that not all of the CTA covered entities actually participate in commerce, so the CTA proposes to regulate “an entire class” just because “some sub-class engages in commerce.” Shultz does not go so far. American Power & Light, likewise, applied to public utility holding companies that used the channels of interstate commerce, so the challenged government reporting requirements were not as broad as those in the CTA.

The government acknowledged that the act of submitting incorporation documents to a secretary of state does not constitute interstate commerce, but it insisted that the CTA is a valid exercise of Congress’s Commerce Clause power under the substantial effects doctrine because some incorporated entities subject to the CTA engage in commercial activity.

The court rejected this argument, first, because the CTA is “‘a historical anomaly’”; indeed, it said it “cannot find, and the parties have not identified, any other State or federal law like the CTA.” Second, the court pointed out that the CTA does not even seek to regulate commercial activity, as substantial effects legislation usually does; the court thus analogized the law to the one struck down in U.S. v. Morrison, which did not regulate commercial activity and was therefore not a valid exercise of Commerce Clause power.

The court also maintained that the law was not necessary and proper to Congress’s regulation of interstate commerce. It pointed to FinCEN’s 2016 regulation requiring covered financial entities to verify the beneficial owners of incorporated parties, explaining that while the 2016 regulation and the CTA “provide FinCEN with nearly identical information, . . . the [2016 regulation] does so in a constitutionally acceptable manner.” That FinCEN rule is triggered by a commercial transaction, unlike the CTA.

The court also found that the CTA was not a valid exercise of the government’s taxing power, even in conjunction with the Necessary and Proper Clause. It first found that the CTA penalties were not a tax. Drawing on NFIB v. Sebelius, the court noted that the penalties were not paid into the Treasury and had no income threshold; the amounts were fixed; the penalty provisions were neither part of the Internal Revenue Code, nor enforced by the IRS; and the penalties are imposed for knowing or willful violations, states of mind that are typical of criminal law. The government’s attempt to justify the CTA’s penalties under the Necessary and Proper Clause would expand that modest clause to the point that it “would sanction any law that provided for the collection of information useful for tax administration and provided tax officials with access.”

The court declined to address the challengers’ claims under the First, Fourth, and Fifth Amendments in the light of its constitutional holding.

The government has appealed to the Eleventh Circuit, briefing is complete, and oral argument is set for September 27, 2024, in Birmingham, AL. While that oral argument looms, five other challenges to the CTA’s constitutionality have been filed in federal courts, including in Maine, Texas, and Michigan.

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