Hide and Seek
A national study released in 2015 reported that “nearly half the residential purchases of over $5 million were made by shell companies rather than named people.”[ii] Because shell companies could often be formed without disclosing the individuals that ultimately owned or controlled them (i.e., their beneficial owners), and could be used to conduct financial transactions without disclosing their true beneficial owners’ involvement, there was a concern that criminals were using such vehicles to launder money through the purchase of real estate and thereby hide, or at least obscure, the illicit origin of their funds. The report explained that many of these purchases were made in all-cash transactions; thus, no lender was involved and, so, the usual due diligence that accompanies a loan application was avoided.[iii]
NY’s First Steps
Later that year, New York City’s Department of Finance revised its form of Real Property Transfer Tax Return to require that any purchaser organized as a limited liability company (an LLC) disclose the identity of its direct (not beneficial) members.
In 2019, the State Tax Law and the City Administrative Code were amended to require any LLC that purchased or sold residential real property containing one-to-four family dwelling units to disclose on the transfer tax return the names and business addresses of all members, managers, and any other authorized persons, if any, of such LLC. If any such person was itself an LLC or other business entity, the amended laws required disclosure of such’s entity’s members, managers, and authorized persons until full disclosure of ownership by natural persons was achieved.[iv]
Treasury Acknowledges the Problem
A couple of years later, the U.S Treasury Department stated there was “a good argument that . . . the best place to hide and launder ill-gotten gains is actually the United States. And that’s because of the way we allow people to establish shell companies.” According to the Treasury, for many years “individual states have been free to set their own rules for incorporating companies, and . . . some states have allowed anybody to establish a shell company without disclosing who really owns it, what we term ‘the beneficial owner.’”
As regards real estate, the Treasury continued, “many corrupt actors can hide their money in . . . Central Park skyscrapers the same way they do in shell companies. An LLC . . . can be listed as the owner. A lawyer can sign the paperwork. Indeed, sometimes the only thing these luxury properties are home to are ill-gotten gains – they’re money laundromats on the 81st floor.”[v]
In the midst of the foregoing developments, FinCEN[vi] has since 2016 used Geographic Targeting Orders[vii] to require U.S. title insurance companies to collect and report information about persons involved in certain residential real estate transactions in a number of major U.S. metropolitan areas, including New York City.
The transactions in question include those in which the purchaser of the real property is a legal entity (such as an LLC), the purchase price is at least $300,000, and the purchase is made without a bank loan or other similar form of external financing by a financial institution that is obligated to maintain an anti-money laundering program and to report suspicious transactions under FinCEN regulations – i.e., an all-cash deal.
With respect to such a covered transaction, the title insurance company is directed to collect information relating to, among other things, the identity of the individual representing the legal entity, the identity of the beneficial owner(s) – i.e., each individual who, directly or indirectly, owns 25 percent or more of the equity interests of the entity purchasing real property in the covered transaction – the purchase price of the real property, and the property’s address.[viii]
Despite the foregoing efforts, data recently published by a government watchdog group indicates that 37 percent of Manhattan real properties (5 times the State average) is owned by LLCs, and 12 percent of Manhattan properties’ true owners are hidden behind LLCs (double the State average).[ix]
Relying upon similar data for other parts of the country, Congress determined that bad actors were exploiting state entity formation procedures to conceal their individual identities when forming LLCs in the U.S. – the ownership of such entities was not a matter of public record and, so, their owners were anonymous.[x] According to Congress, this lack of available beneficial ownership information impeded the efforts of law enforcement to investigate LLCs (and other business entities) that these bad actors would use to commit crimes affecting commerce, including tax fraud.
Therefore, in early 2021, the federal Corporate Transparency Act (CTA) was enacted into law – with an effective date of January 1, 2024[xi] – for the purpose of remedying the dearth of information on the true ownership of LLCs and other business entities by requiring such entities[xii] to submit certain information to FinCen regarding their beneficial owners.
NY Joins the Feds
The LLC Transparency Act (the Act) was enacted by New York just before the close of 2023[xiii] and will become effective 365 days after its date of enactment.
According to the sponsor memo,[xiv] the Act builds on previous efforts (described above) to require the disclosure of LLC members and managers involved in real estate transactions in New York.
Specifically, it seeks to end the practice of anonymous ownership of a significant portion of New York real estate which, according to the memo, is used to avoid taxes, launder money, and commit or facilitate other crimes. Anonymous ownership also “hampers policymaking and upends centuries of precedent by obscuring the answer to the question: who owns what?”
In order to achieve this goal, the Act defines the beneficial ownership of an LLC and requires the disclosure of the identities of its beneficial owners upon formation of a New York LLC or upon registration in the State of a non-New York LLC.[xv]
The sponsor memo acknowledges the federal government’s passage of the CTA, which requires FinCen to collect beneficial ownership information from corporations and LLCs in a private, government database. “Unfortunately,” the memo continues – not without justification[xvi] – “the inaccessible nature of the new federal database means that this information will serve no use for civil society or local government in New York, denying New Yorkers the many benefits that beneficial ownership transparency offers.”
In other words, New York wants to avoid going through some prescribed protocol to ask the Feds for information and then wait for it to be provided. The State may also be eager to uncover tax evaders on its own as Albany faces significant projected budget gaps.[xvii] The creation of its own database with information regarding the beneficial owners of those LLCs that are formed and/or operated in the State, and that will be accessible to New York government agencies and law enforcement, will assist in uncovering misconduct, including tax evasion, money laundering, and other unlawful activity that the State believes has been facilitated by the otherwise opaque ownership structure of an LLC.
Still, the Act adopts the same standards promulgated by the Feds pursuant to the CTA and requires that the same information also be filed with New York’s Department of State.[xviii]
Thus, the Act requires that LLCs submit an initial report, including a list of beneficial owners, with the documents submitted to the Department of State when organizing an LLC in New York. It also requires that updates and corrections to information required in an initial report be filed with the Department of State.
Each reporting company formed on or before the Act’s effective date must file the information required with the Department of State no later than January 1, 2025.
The Act enumerates the information that must be disclosed by an LLC that is a “reporting company”[xix] when identifying one of its beneficial owners.[xx] The list of items is almost identical to the information that must be disclosed to FinCen pursuant to the CTA: each beneficial owner must be identified by: (1) full legal name; (2) date of birth; and (3) current business street address (not residential, as in the case of the CTA).[xxi]
Of course, the Act provides that this identifying information of beneficial owners will be kept confidential other than for purposes of law enforcement or as otherwise required to be disclosed by court order.
At first blush, a covered LLC’s preparation and submission of information to New York regarding its beneficial ownership may not seem burdensome – after all, the CTA already compels the LLC to provide substantially the same information (and more) to FinCen.
What’s more, LLCs that were organized, or that were qualified to do business in, New York prior to the effective date of the Act have until January 1, 2025 to file their initial reports with Albany.
Still, such an LLC and its beneficial owners will now be subject to a greater risk of inadvertent public disclosure, whether as a result of a regulator’s negligence or a bad actor’s illicitly accessing the regulator’s “secure” database.
There is also the requirement to update an LLC’s original submission following certain changes to the LLC’s beneficial ownership; for example, the hiring of an individual who will exercise “substantial control” over the LLC,[xxii] the transfer of membership interests representing at least 25 percent of the LLC’s outstanding equity, or the transfer of a lesser amount – say, by way of a gift or sale to a member of the transferor’s family – that causes the transferee to become a 25 percent owner.[xxiii]
Thus, gift transfers that would otherwise not be reportable to the State – because New York does not have a gift tax and because the transfer does not represent the transfer of a controlling interest in an entity that owns an interest in New York real property – will now have to be disclosed.
Query whether these risks and responsibilities may dissuade certain legitimate investors – both residents and nonresidents – from acquiring real property in New York, or encourage others to limit[xxiv] or even eliminate their New York holdings.[xxv]
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[i] Remember the 1984 hit by The Romantics?
[ii] https://www.nytimes.com/2015/02/08/nyregion/stream-of-foreign-wealth-flows-to-time-warner-condos.html. In general, a shell company is a closely held limited liability company that has no physical presence beyond a mailing address and generates little to no independent economic value.
[iii] According to FinCen, nearly 50 percent of residential real estate sales in Miami-Dade County were all-cash transactions in 2015 and 2016.
[iv] Tax Law Section 1409 and NYC Admin Code Section 11-2105. https://nyassembly.gov/leg/?default_fld=&leg_video=&bn=A07190&term=2019&Summary=Y&Text=Y.
[vi] Financial Crimes Enforcement Network – a division of Treasury.
[vii] The most recent Order was issued October 22, 2023. 31 U.S.C. Sec. 5326(a); 31 C.F.R. Sec. 1010.370. https://www.fincen.gov/sites/default/files/shared/Phase_17_RRE_GTOs_Order_FINAL_508C.pdf.
[viii] In 2017, FinCen reported that over 30 percent of the real estate transactions reported under the GTOs involved a beneficial owner or purchaser representative that had been the subject of unrelated suspicious activity reports filed by U.S. financial institutions. In other words, the beneficial owners or purchaser representatives in a significant portion of transactions reported under the GTO had been previously connected to a wide array of suspicious activities. https://www.fincen.gov/sites/default/files/advisory/2017-08-22/Risk%20in%20Real%20Estate%20Advisory_FINAL%20508%20Tuesday%20%28002%29.pdf.
[x] In contrast to the U.S., member countries of the European Union are required to have corporate registries that include beneficial ownership information.
[xi] Title LXIV of the National Defense Authorization Act for FY 2021, Pub. L. 116-283, which added 31 U.S.C. Sec. 5336.
[xii] “Reporting companies.” 31 U.S.C. Sec. 5336(a)(11).
[xiii] S. 995B, enacted December 22, 2023.
[xiv] https://www.nysenate.gov/legislation/bills/2023/S995/amendment/B. [xv] According to the sponsor memo, the limited liability protection afforded by an LLC is a legal privilege conferred by the state upon an individual owner of the LLC, and the receipt of such privilege should be conditioned on the identification of the individual benefiting from it. The memo goes on to concede that permitting anonymous limited liability companies to do business in New York was “a public policy mistake that deserves correction.”
[xvi] The CTA authorizes FinCen to disclose information upon receipt of “a request, through appropriate protocols . . . from a State [or] local . . . law enforcement agency, if a court of competent jurisdiction. . . has authorized the law enforcement agency to seek the information in a criminal or civil investigation.”
[xviii] Although it is based, by and large, upon the CTA, the New York statute’s reach is not as broad as the CTA’s. Specifically, it covers only LLCs, not corporations.
[xix] In general, an LLC that employs not more than 20 employees on a full-time basis in the U.S., or that filed Federal income tax returns in the previous year reflecting not more than $5 million in gross receipts or sales in the aggregate,[xix] or that does not have an operating presence at a physical office within the U.S.
[xx] For purposes of the Act, a “beneficial owner” with respect to an LLC means an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, exercises “substantial control” over the LLC or who owns or controls not less than 25 percent of the ownership interests of the LLC.
[xxi] A unique identifying number from an acceptable identification document defined in 31 U.S.C. § 5336 (a)(1) may also be provided.
[xxii] Query whether this will cover individuals who are hired by a holding company LLC that oversees several subsidiary business entities, including other LLCs.
[xxiii] LLCL Sec. 211(d)(11) as added by Sec. 4 of the Act.
[xxiv] By reorganizing or otherwise.
[xxv] Might the Act be the final straw, following the influx of illegal aliens, the State’s and the City’s budget woes, the still unsettled office market, and the high interest rate environment?