Compliance with the Corporate Transparency Act (CTA), passed by Congress in 2021, goes into effect on January 1, 2024. The CTA contains a new disclosure scheme that will require more than 27,000,000 businesses in the United States to file annual reports with the federal government, specifically with the U.S. Department of Treasury’s Financial Crimes Enforcement Network (known by the dystopian sounding acronym “FinCEN”). The CTA mostly flew under the radar until recently, but now that the effective date is nearly here, businesses need to prepare for their new reporting obligations, and the risk they face if they fail to make annual reports to FinCEN.
The Corporate Transparency Act
The CTA was enacted as part of the National Defense Authorization Act (NDAA) for Fiscal Year 2021. The Treasury issued the final rule implementing the CTA in September 2022. The CTA represents a significant step in addressing issues related to corporate transparency and preventing the illicit use of anonymous shell companies for illegal activities such as money laundering, terrorism financing, and tax evasion. It does this by requiring corporations, LLC’s, and similar entities in the United States to disclose information about their ownership. The thought being that providing such information to the federal government was needed to protect national interests and enable effective law enforcement.
Key Features of the Corporate Transparency Act
Fundamentally, the CTA is a disclosure regulation. The CTA requires certain corporations, limited liability companies (LLCs), and similar entities to report information about their beneficial owners to the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury.
Domestic reporting companies are corporations, LLC’s, LLPs, or any other entity that was created by the filing of a document with a secretary of state or any similar office under the law of a state of Tribal government.
Foreign reporting companies are corporations, LLC’s, LLP’s, or any other entity under the law of a foreign country that is registered to do business in any state or Tribal jurisdiction by the filing of a document with the secretary of state or any similar office.
Sole proprietors that do not use a single member LLC are not considered a reporting company.
While the CTA’s reach is expansive, several exemptions apply. These include:
Recognized non-profit organizations;
Publicly traded companies;
Certain financial institutions; and
Exempt entities are generally those which have regular reporting obligations under other federal laws.
Disclosure of “beneficial owner”
As noted, the CTA requires reporting organizations to disclose their “beneficial owner”. A beneficial owner, defined as any person who directly or indirectly, either exercises substantial control over a reporting company or owns and controls at least 25% of the ownership interest in the reporting company. “Ownership” interest here includes either capital or equity ownership in the company.
Companies covered by the CTA are required to report the names, addresses, dates of birth, and unique identification numbers (such as a driver’s license or passport number) of their beneficial owners to FinCEN.
Access to Beneficial Owner information
CTA’s purpose is to enhance law enforcement efforts in certain areas. To this end, the CTA includes a liberal information sharing provision that allows law enforcement agencies and certain other governmental authorities to have access to the information reported to FinCEN, helping them in investigations related to financial crimes. As of the date of this post, the final regulations are unclear on whether beneficial owners will be made aware their information is being shared. It may also be the case that information may be shared without probable cause being shown.
Reporting companies must ensure their compliance with the CTA. Failure to make required filings with FinCEN can result in financial penalties that range from $500 to $10,000 per violation, and potential jail time of up to two years. All new entities organized after January 1, 2024, must disclose their beneficial ownership within 30-days of creation. Entities organized before January 1, 2024, must file their disclosures with FinCEN by January 1, 2025.
Our attorneys can assist your enterprise in understanding and navigating your obligations under the Corporate Transparency Act. Contact us to learn how we can help.
Stock options can be a very effective way for early-stage businesses to attract and retain talent. While offering stock options can be an easy and seemingly inexpensive way to hold on to talented workers, there are a few tax rules to keep in mind. In this blog, we’ll explore the most common and relevant tax code section related to using stock or stock options as part of a worker’s compensation – Internal Revenue Code § 83.
Stock as Taxable Income
The first thing any business, and worker, should consider when using stock as part of a compensation package is whether the stock, or stock option, will be treated as taxable income. Internal Revenue Code § 83 is a tax provision that applies to property, including stock and stock options, transferred to an employee in connection with the performance of services. Under § 83, the value of the property transferred is generally included in the employee’s gross income in the taxable year in which the property becomes vested. The value of the property is generally equal to the fair market value of the property at the time of vesting, minus any amount paid by the employee for that property.
Stock as Equity Compensation
§ 83 is of increased importance because it affects the tax treatment of equity compensation for both employers and employees. Employers need to be aware of § 83 when the following conditions apply:
Designing equity compensation plans and granting equity to employees, as it can impact the amount and timing of tax deductions that the employer can claim.
When receiving equity compensation, as it can impact the amount and timing of taxes that they owe.
An employee who receives equity compensation that is subject to § 83 may owe taxes on the value of the property when it becomes vested, even if they have not yet sold the property. This can create a cash flow issue for employees who may not have the funds available to pay the taxes owed, as well as coming as a surprise to the employee who most likely didn’t expect to have a tax liability on the options or shares they received.
Because of its potential impact on both employers and employees, it is important to understand § 83 implications when designing, granting, and receiving equity compensation. Fortunately, in most cases, an election under IRC § 83(b) most likely addresses everyone’s concerns.
Internal Revenue Code §83(b) election
“§83(b) election” refers to a provision in the United States Internal Revenue Code (IRC) Section 83(b). This section applies to compensatory stock options, restricted stock units (RSUs), and other forms of equity-based compensation that are granted to employees, consultants, or other service providers by their employers or clients. When a person receives equity-based compensation, like stock options or RSUs, there is often a vesting period during which they do not fully own or have the right to the equity. Vesting is a process by which an individual gains ownership rights to the equity over a certain period of time or upon the achievement of specific milestones.
The §83(b) election allows an individual to choose how they want to be taxed on the value of the equity they receive during the vesting period. Here’s how it works:
Standard Taxation: Without making an 83(b) election, an individual would typically be taxed on the value of the equity at the time it vests. This means that as the equity vests over time, the individual’s taxable income increases accordingly. For example, if an employee is granted stock options that vest over a four-year period and the value of the stock increases during that time, the employee will be taxed on the higher value as the options vested.
83(b) Election: By making an §83(b) election, an individual chooses to include the value of the equity at the time it was granted (not at vesting) in their taxable income for the current tax year, even though the equity has not yet fully vested. This can be advantageous if the equity’s value will most likely be fairly low at the time of grant and is expected to appreciate significantly by the time it vests.
By paying taxes on the lower grant value, the employee can expect to end up paying less in taxes compared to waiting until vesting. In addition, if the employee holds the equity for more than one year after making the election, any future appreciation in value will most likely be treated as long-term capital gain, resulting in a lower tax rate compared to ordinary income tax rates.
There are some risks, however. If the election is taken and the equity doesn’t end up vesting due to job loss or other reasons, the taxpayer will not get a refund for the taxes paid on the unvested equity. Also, the taxpayer will need to pay taxes on the value of the equity at grant immediately, even if they haven’t received any cash from it.
On balance, making the election under §83(b) is a good thing for both the start-up and the worker. Interested in learning more about developing stock option plans?
Used to protect employers’ customer relationships, special processes, trade secrets, and confidential information.
Used to protect business confidential and proprietary information.
Prevent employees/contractors from working for a competing business after leaving current employer.
Prevent employees/contractors from sharing business confidential and proprietary information.
Agreements are enforced for a predetermined period of time.
Agreements may have a longer duration and can be enforced for an indefinite period of time.
Apply in a limited geographic space.
Apply in a broader geographic scope.
Noncompete agreements are typically used to prevent employees, and contractors in certain situations, from working for a competing business after leaving their current employer. These agreements can help to protect the employer’s customer relationships, special processes, trade secrets, and confidential information. Noncompete agreements are commonly used in industries in which an intellectual property plays a significant role and is critical to the enterprises’ strategy, such as tech, healthcare, and finance industries, although they may be used elsewhere when appropriate. Under a noncompete agreement, the employee is prevented from working in the same sector for a predetermined period of time. This means the employer can train the worker and build their business in the sector without worrying about creating a resource that will benefit a competitor in the process. There are, however, some very specific concerns with noncompete agreements that must be kept in mind.
Because noncompete agreements limit a person’s ability to find employment, public policy and state laws limit them, to make sure they serve a valid purpose. In most states, noncompete agreements must be closely tailored to the employer’s business needs, apply in a limited geographic space, and last for a reasonable duration. For example, a noncompete that prohibits a worker from working anywhere in the world for the foreseeable future would almost certainly be found unenforceable. In contrast, an agreement that lasts one year and applies in the geographic area where the employer operates may be seen as reasonable. Even so, in some states noncompete agreements are not allowed in most instances. One exception to broad state prohibitions against noncompetes include instances where an owner sells a business’ assets or the business as a whole–noncompetes are permitted in such situations to protect the value of the business transferred. Due to the state specific nature of the limitations, it is important to consult qualified counsel for advice.
Nondisclosure agreements, also known as confidentiality agreements, are used to protect a business confidential and proprietary information. These agreements may be used with employees, contractors, and other third parties who may have access to confidential information, such as business plans, pricing strategy, IP, and financial data. In contrast to noncompete agreements, nondisclosure agreements may have a longer duration and broader geographic scope of application. Indeed, it may be possible to have an indefinite period of application. Nondisclosure agreements will carefully define the scope of the information they cover, and in most cases, nondisclosure agreements will include provisions that will allow some information to be disclosed under certain, well-defined circumstances. In addition, these agreements should contain clear enforcement mechanisms that protect the disclosing party if a warranted disclosure occurs. Consequently, it is extremely important that nondisclosure agreements be carefully drafted, taking into account the disclosing parties’ interest and risks.
In many cases, a broad employment agreement will add both noncompete and nondisclosure clauses. Generally, this will save time and make for an easier agreement. The parties should consider what might happen if a court were to find the entire agreement invalid for some reason. If this should happen, these clauses might not offer the protection the employer seeks.
Drafting carefully crafted documents that align with the enterprise’s goals, and values, is important in all contexts, and should be kept in mind here. Agreements that do not comply with state law, or which do not adequately provide the protection that the enterprise requires, may end up being more destructive than one expects.
As enterprises grow, they demand more people power. And as they work to respond to that demand, enterprises inevitably encounter employment law questions. To avoid costly and damaging missteps, it is important for founders and leaders to understand the laws involved in the employer/employee relationship.
“Employment law” refers to a set of legal rules, regulations and principles that govern the relationship between employers and workers in the workplace. This includes a very wide range of topics (such as hiring/firing, compensation and benefits, workplace safety and health, Civil rights/discrimination, harassment, and employee contracts), each of which may have a significant impact on the enterprise as it grows and operates. Consequently, founders and entrepreneurs should be vigilant about the relationships between the enterprise and its workers. At the same time, staying on top of these relationships can be difficult due to the complexity of the laws that are involved and the role they play.
Employment laws aim to protect the rights and interest of workers, and they do this by ensuring that employers comply with legal requirements which are often enforced by government agencies. Some examples include the Fair Labor Standards Act, which establishes minimum wage and hour laws for employees, the Americans with Disabilities Act, which prohibits discrimination against individuals with disabilities, Title VII of the Civil Rights act, which prohibits workplace discrimination, and state laws that include Workers Compensation requirements. Each of these laws regulate the employment relationship, although in different ways and to varying degrees.
Failure to comply with employment laws can result in legal disputes, including litigation, financial penalties, and damage to the enterprise’s reputation. Startups face a particular threat in this area because they often do not have resources to hire a dedicated HR person to handle legal compliance. In addition, the informal culture of many startups can make it difficult to ensure that their hiring, firing, compensation, and benefit packages are in line with legal requirements.
Some of the common areas of concern for startups include minimum wage and overtime requirement, employment classification (specifically, whether a worker is an employee or independent contractor), tax compliance, and use of equity as part of an incentive program. Other areas of concern involve discrimination and harassment or workplace safety claims. Disputes in any of these areas can lead to lawsuits, fines, and regulatory intervention. When processes like these begin, the time and energy they take from a startup can be devastating.
Even while the concerns are significant, they can be managed. This begins with a comprehensive overview of employment policies, practices, and procedures to identify areas of legal risk, ensure compliance with federal, state and local laws, and assess the overall HR strategy. These assessments are often called an “Employment Law Audits” and they provide a road map of where corrective steps may be needed – avoiding the disputes and conflicts that can derail success – and in many cases how to effectively protect the enterprise’s business and intellectual property.
We are planning a series of blogs with additional information on employment law topics that we hope are helpful as founders begin to grow their enterprises. The first topic, found below, discusses employment agreements.
Thinking through when you need an employment agreement.
Employment agreements are an effective way to manage the employee/er relationship.
Here are some things leaders should consider when thinking about putting employment contracts in place for their employees and contractors.
An employment contract serves as a legal agreement between the employer and employee and contains the terms and conditions of the working relationship. Employment contracts are important for several reasons:
Clarify expectations: The employment contract describes work responsibilities, compensation, benefits, work hours, at-will status, and other terms of employment. This makes it less likely for misunderstandings to occur and ensures both parties share an understanding of what can be expected.
Protect rights: The employment contract may also include provisions that protect each parties’ rights, such as confidentiality, non-compete rights, and intellectual property rights. These are important provisions for any enterprise but have a heightened importance for most startups depending on new innovations as part of their business strategy.
Define a mechanism for dispute resolution: The employment agreement can provide an effective dispute resolution mechanism should a disagreement arise. This may include mediation or arbitration provisions before litigation, which is helpful in most cases, as well as to determine where any litigation must be filed and heard, which can be very helpful when remote workers are involved. This means that an employer can require any claims to be heard in a court near the employer’s offices, instead of somewhere remote and out of state.
Comply with local legal requirements: Employment contracts may be required under local laws in some jurisdictions. Even when they are not, they are still a good practice to have in place to ensure compliance.
Putting employment contracts in place is easiest at the beginning of the employment relationship before the employee starts working. It is possible to put the agreement in place after the relationship has begun, but employers must keep in mind the need to advance additional consideration for the new agreement.
Employment contracts will often contain a number of common elements, although they may differ depending on the specific job and industry, including:
Job title and description: stating the employee’s responsibilities and expected performance standards and goals.
Compensation: stating the salary or wage the employee will receive, along with any. Bonuses, commissions, or other forms of incentives. (Note that stock options will be treated in a separate agreement.)
Benefits: where details on any benefits (health insurance, retirement plans, leave and other perks).
Employment terms: this section describes the length of employment, including start and end dates, if applicable, and any termination clauses. Typically, this would include discussion of termination for cause or without cause – and without cause is most common.
Confidentiality Clause: any requirements for maintaining confidentiality, which are extremely important when the employee has access to proprietary information, will be included.
Non-compete clauses: this section will refer to the reasonable limits placed on an employee’s ability to work for a competitor after their employment ends. State laws regulate non-compete clauses, so employers should be certain that they can rely on the language in their agreements.
Intellectual Property Rights: the “work for hire” doctrine will most often control when an employee creates intellectual property for an employer. The employment contract should clearly document the parties IP rights in light of this doctrine.
Dispute resolution and forum selection: this section should contain a framework for resolving disputes as efficiently, and economically, as possible. Including choice of law.
Employment contracts offer clarity to both employers and employees and can help you avoid conflict in the future. The lawyers of Cutting Edge Counsel are available to meet with you to explore how we may be able to assist you with your employment law questions. Schedule a free consultation.