If a person residing in a community property state beneficially owns 25% or more of the ownership interests of a reporting company, would the individual’s spouse also be considered a beneficial owner of the shares simply because they are a spouse?
Quite possibly. The treatment of the ownership of interests in property, such as equity in a company required to file reports under the Corporate Transparency Act of 2020 (CTA), is generally defined by the laws of the state in which the holder of the ownership interest is a resident. The nine states with community property laws and four states with opt-in community property laws add complexity to this analysis.
Under the CTA, an individual may be considered to own or control an ownership interest in a reporting company through ownership with one or more other persons of an undivided interest in the ownership interest of the reporting company. This could include ownership by spouses through community property rights of the equity in a reporting company even though title to the ownership interest is held in the name of only one spouse.
In general, most community property laws treat anything earned during the marriage, or acquired with earnings received by the parties during the marriage, as jointly owned by both parties. Property owned by a spouse before marriage (or acquired while legally separated) and gifts (including inheritance) received by one spouse during marriage are generally not treated as community property, unless somehow commingled with and inseparable from community property assets. Whether earnings from separate property constitute community property varies by state. State laws also vary as to the extent to which a spouse with sole title has sole authority to exercise ownership rights over community property.
Currently, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin have some version of community property laws that serve as the default law governing the ownership of spousal interests in property. Alaska, Florida, South Dakota and Tennessee have opt-in community property laws, which allow the parties to subject themselves in some way to community property concepts, but on an elective basis only and in some cases limited to trusts. The community property laws in California, Nevada, New Mexico and Washington cover domestic partners as well as spouses.[1]
If a person resides or has resided in more than one state, the analysis can be further complicated. In addition, a prenuptial agreement (or other agreement relating to community or separate property rights) between spouses can override the provisions of community property laws.
For example, under the California Family Code, “except as otherwise provided by statute, all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in this state is community property.” The interests of each spouse in community property are present, existing and equal interests, and (with some exceptions), either spouse may manage or control the community personal property, subject to fiduciary obligations to the other spouse. [2] The California Family Code includes a number of statutory exceptions to this general rule, including for property owned by a spouse before the marriage or acquired while separated, gifted to or inherited by a spouse or whose treatment as community or separate property is altered by contract between the parties.
Given the variations from state to state in the terms of community property laws, the separation of certain property from the community property umbrella, the ability to alter treatment of property through agreement between the spouses, and the ability to transform certain separate property into community property by commingling it with community property assets, it can be complicated to assess the extent to which a particular piece of property – such as equity in a CTA-reporting company – is subject to a state’s community property laws.
The treatment of a spouse as a beneficial owner of a reporting company because of community property rights applies with respect to ownership interests in or other property rights related to equity of the reporting company. This treatment would not apply to other means of “substantial control” over the reporting company by a spouse that are not derived from ownership interests or other property rights, such as by virtue of the spouse’s position as a senior officer of the reporting company. The latter would still be relevant for CTA purposes as senior officers are deemed beneficial owners of a reporting company by virtue of those positions but does not relate strictly to the analysis for beneficial ownership of any equity held by such persons.
Given the complexities of both the community property laws and the beneficial ownership rules, when assessing its beneficial ownership information reporting obligations under the CTA, a reporting company will need to be mindful about the following, if a direct or indirect beneficial owner has a spouse:
- Whether any direct or indirect ownership interests are beneficially held by persons who are potentially subject to community property laws by virtue of current or prior residence of those persons in one of the community property states;[3]
- Whether the reporting company needs to gather additional facts from an identified beneficial owner to determine whether his or her ownership interests should be considered community property or separate property under applicable state law;
- Whether that inquiry should include questions about the relevant terms of any applicable prenuptial or other agreements; and
- If ownership interests are held in a trust created by one or both spouses, whether the reporting company needs to gather additional facts from the spouses to assess the impact of any unique community property laws applicable to trusts on the manner in which the ownership interests were contributed to or are held by the trust.
To make these assessments, reporting companies will want to ensure that they have procedures in place to prompt the necessary inquiries and that they document in their records their analyses and conclusions. Because community property laws and CTA rules are complex, it may be difficult for a reporting company to determine the nature of a beneficial owner’s ownership interest. The reporting company may need to seek, and rely upon, representations from an identified beneficial owner about his or her current and prior residence, marital status and spousal property rights, as well as guidance from advisors about the nature and extent of applicable community property laws.
Ultimately, the reporting company will want to have made sufficient inquiry, including any necessary representations from an identified beneficial owner, to reasonably conclude that it should, or should not, include a spouse of an identified beneficial owner as an additional beneficial owner due to community property rights in an ownership interest. Those responsible for a reporting company’s CTA compliance should consider strategies to explain the need for this information to beneficial owners and recognize its private nature, as these queries involve personal and highly sensitive areas.
[1] Subsequent references in this discussion to “spouse” include “domestic partner” to the extent applicable in the relevant state.
[2] See, generally, California Family Code, §§ 751, 760 and 1100. A notable exception to these rules relates to the ability of a spouse to act alone in all transactions (with prior written notice to the other spouse for certain actions) where the spouse is operating or managing a business consisting of community property assets.