Benefitting from Business Trusts
When considering a trust for a business, an entrepreneur may have questions such as who are the sole beneficiaries and the trustees of a business trust. Trusts come with a whole host of new languages and considerations that need to be made. Placing a business in a trust can be beneficial for the business and the people who benefit from it; however, the creation and use of a trust for a business needs to be handled correctly and managed effectively to keep these benefits steady throughout life of the trust. Considering which type of trust to create also can affect the way that the income is designated and how the assets are kept. Additionally, certain rules must be considered when determining who will fill each role to ensure that the trust is legal and carries out its business correctly. While they may seem complicated, trust for a business can ensure that the business continues to function well for years to come.
Business Trusts Explained:
Many businesses are formed as corporations or limited liability companies to help protect the business owner from liability and create a separate entity from their owners. However, this is not always the best option for small business owners, especially when they are concerned about how the business will transfer to their heirs once they are no longer able to handle the business. A business trust is a way that business owners can benefit from holding the business as a separate entity and having limits to the liability. In addition to these perks, it also allows more privacy, has less oversight than a business filing, and provides an estate plan. Trust takes the assets of a business and holds them for the benefit of the beneficiary. This is managed by someone called the trustee. This setup allows a business owner to continue to run or benefit from the business while allowing the beneficiaries to receive benefit from the trust and ensures the assets are passed along effectively.
The Elements of a Trust:
To better understand a trust, it is important to understand the elements that accompany a trust. As stated above, several terms that are common in trusts can feel foreign to individuals who have never experienced them before, so this section will walk through each term as it discusses the elements. For trust to be effective, it needs to have these four elements. The elements of a trust are:
- Grantor: A grantor is a person who gives the property or assets to the trust. For a business trust, this is often the business owner or the agent of the business. This person holds the ownership interest in the business for income and estate tax purposes.
- Trustee: A trustee is a person or firm who is appointed to hold the assets of the business for the benefit of the beneficiaries. The trustee has a fiduciary duty to hold and manage the assets for the benefit of the beneficiaries. This means that they are subject to discipline if they do not fulfill their duties correctly. This role can be combined with the grantor role, which can be common in business trusts, as long as they are not a beneficiary as well.
- Property: Property is the assets that will be held in the trust. For a business, this can be the profits, patents, any real estate holdings, or other assets that the business has. The grantor gives this to the trust to hold.
- Beneficiaries: Beneficiaries are recipients of the assets held in the trust. Depending on the type of trust, the beneficiaries will receive their income from the trust in a variety of ways, but they receive the income and the benefit of the trust. They also hold the fiduciary duty of the trustee, which means that they can ensure that the trustee is acting in their best interests. Business trusts are often shareholders, investors, or family members of small family-run businesses. The grantor may be a beneficiary if they are not the sole beneficiary.
These elements will be included in a declaration of trust, which will outline the trustee’s duties and obligations and will be the controlling document in any questions about the trust. The purpose of the trust and the duties that the trustee will have will be to operate the business.
Types of Trusts:
There are three types of trusts that can be created to hold a business. Each has a specific purpose and allows the business to be conducted in a certain way. The three types of trusts are:
- Grantor: A grantor trust is the kind of business trust where the grantor is also the trustee, so they control the oversight and daily dealings of the business. They maintain control and authority over the trust. However, they are not taxed separately and must pay income taxes on the trust’s income, which can be a downside for certain grantors. In this type of trust, the grantor is the main beneficiary.
- Simple: A simple trust is the most regulated trust. In a simple trust, all earnings from the trust must be distributed to the beneficiaries, but the principal amount, what was placed in the trust initially, cannot be distributed to the beneficiaries. Simple trusts are not allowed to make charitable donations, and beneficiaries still pay income tax on their earnings. However, there are certain expenses that the trust can deduct, and it will file a tax return.
- Complex: A complex business trust is a type most similar to a regular trust. It can accumulate income, make distributions from the principled amount, and make and accept charitable donations. It must file a tax return, but it can take deductions for certain expenses.
In addition to these types of trust, a trust can also be revocable or irrevocable. These distinctions impact how permanent the trust arrangement is.
- Revocable: A revocable trust is a trust where the grantor may change the terms of the trust or revoke the trust completely. If a trust is revoked, the assets will return to the grantor and the trust arrangement will cease to exist.
- Irrevocable: An irrevocable trust cannot be revoked, except in very specific circumstances. These trusts are helpful in estate planning, but they may not always be the best way to oversee a business where probate issues are not the main focus of the trust.
Understanding the different types of trusts is important when determining how to set up a trust. These are simplified explanations of the types, so it is important to speak with a trusted professional when creating a trust.
Creating a Business Trust:
Businesses are created under state laws, so each state will have a slightly different take on creating a business. For this reason, it is again important to speak with a trust professional about creating trust. However, many states follow a somewhat similar pattern, they only change on the particulars. The steps will likely follow something like the following.
- Creation: Before trust can be created, the business must be created. The business may have been functioning without incorporating for quite some time, or the business may be a new idea. Either way, there must be some sort of business with assets to put into the trust.
- Declaration: The grantor must make a declaration of trust. This declaration will name the trustee and spell out their duties.
- Registration: To receive the benefits of a business trust, the trust will usually need to be registered with the state. This will vary depending on the state.
There are often other considerations, such as employer tax identification numbers, bank accounts, and other clerical details that may need to be completed before the business may operate under the trust. Taking care to follow the procedure set out by a state will ensure that the business trust is operational as soon as possible.
Benefits and Drawbacks of Trusts:
The final consideration of business trusts is to determine if a business trust is the best organization for the business. Some several advantages and disadvantages accompanying business trusts, and careful consideration can help determine if it is the best option for the business. The advantages of business trusts are:
- Liability: Creating a business trust creates an entity for the business that is separate from the business owner, which is beneficial for the owner. Without this other entity, the owner’s assets can be seized as the result of a lawsuit against the company or other issues. Trusts limit the liability of the owner from any issues that the trust may have.
- Privacy: Business trusts allow an increased level of privacy because the documents that need to be filed are not public, whereas the documents that outline the business and its purpose will be public when incorporated. This is beneficial when the business is unique or the structure is something that the owner would like to keep close.
- Flexibility: The way that distributions are granted to beneficiaries is more flexible, especially if the trust is complex. This allows the business and the trustee to make wise decisions that will benefit the beneficiaries.
The disadvantages are:
- Time Limits: Many states have caps on the length of trust, and the longest of these is usually 99 years. This means that eventually the trust will expire and the business will need to be reorganized.
- Expense: Business trusts can be expensive to create and maintain, especially if the trustee is someone that the business needs to hire.
- Complicated: Compliance with the legal parameters for a business trust is often difficult and trust professionals need to be hired, which can add to the expense.
While these disadvantages may turn away some business owners, the advantages of a business trust can be worthwhile if the time and money to establish are available. Creating trust can help ensure the business is managed well and continues to be managed well for the generation to come.
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