Trusts are usually associated with estate planning, but trusts can also apply to business operations. As a small business owner, you can hold the business in a trust instead of using a business entity such as a limited liability company (LLC) or corporation. Business trusts offer several potential benefits—and drawbacks—compared to a traditional business structure. Understanding their pros and cons, the different types, and the legal implications can help you to decide whether a trust makes sense for your business.
How Does a Business Trust Work?
A trust is an agreement that allows one party, known as a trustee, to hold, manage, and direct assets or property on behalf of another party, called the beneficiary.
In a business trust, a trustee manages a business and conducts transactions for the benefit of its beneficiaries. The trustee, which can be a company or an individual (including the business’s owner), can be authorized to distribute business income and transfer property to beneficiaries.
A business owner can be the sole trustee of the trust that holds the business and be a trust beneficiary, as long as the business owner is not the sole beneficiary. Commonly, the beneficiaries of a business trust are investors or shareholders. If it is a family business, the beneficiaries might be the owner’s heirs.
What Are the Different Types of Trusts?
Entrepreneurs can choose from the following types of trusts, as classified by the Internal Revenue Service (IRS):
- Grantor trust: A grantor is the individual who creates a trust, transfers business interests into it, and controls beneficiary distributions from it. With this type of trust, the grantor maintains control and authority over the trust. In addition, the grantor and the grantor trust are not treated as separate tax entities. The grantor must pay taxes on the trust’s income.
- Simple trust: Simple trusts must distribute all earnings from trust assets to the beneficiaries, but the principal amount placed in the trust cannot be distributed. Simple trusts are also prohibited from making charitable donations. Beneficiaries are required to pay taxes on any income they receive from the trust. A simple trust can deduct certain expenses and must file a tax return. A simple trust that does not meet the IRS definition may be reclassified as a complex trust.
- Complex trust: Unlike simple trusts, complex trusts are legally permitted to accumulate income, make distributions other than income, make charitable donations, and take charitable deductions. Like simple trusts, complex trusts must file tax returns and can deduct certain expenses.
Note that a business trust can be a revocable trust or an irrevocable trust. With a revocable trust (i.e., a living trust), the grantor can change the terms of the trust or revoke the trust entirely and take control of the assets it contains. An irrevocable trust, by definition, cannot be easily changed or revoked.
What Are the Pros and Cons of a Business Trust?
Depending on the type of trust formed, business trusts may offer the following advantages over some traditional business structures:
- Avoidance of probate upon the death of the business owner
- Reduction or elimination of estate taxes
- Business continuity when the owner dies or become incapacitated
- Separation of business assets from personal assets (similar to an LLC)
- Greater privacy than an LLC, since public filings are not required for a business trust
- Protection of assets from creditors
- Simpler formation process than some traditional business structures
Business trusts can also involve the following complications:
- Ongoing costs to maintain the trust (e.g., paying a third party to manage it)
- Challenging legal regulations (e.g., the IRS does not recognize a business trust as a type of business organization)
- Fiduciary relationship between the trustee and the beneficiaries requires the former to act in the best interests of the latter and may be different than the duties required in a typical business structure
Because each business is unique and the various types of business trusts are subject to different regulations, the pros and cons of a specific trust arrangement should be evaluated individually with the help of a knowledgeable attorney. If you have questions about business trusts and whether one can be used to your advantage, we encourage you to reach out to our team to discuss specific trust strategies. Please call our office or contact us to speak with an attorney.
FAQs
In a business trust, a trustee manages a business and conducts transactions for the benefit of its beneficiaries. The trustee, which can be a company or an individual (including the business's owner), can be authorized to distribute business income and transfer property to beneficiaries.
What is the difference between a trust and a business trust? ›
An individual trust typically contains assets such as money or property, but a business trust holds the rights to an individual's stake or interest in a business. As a result, a business trust can be the legal entity that technically owns a business. Business trusts can have one or multiple beneficiaries.
What is the disadvantage of trust in business? ›
The disadvantages include:
A trust is a complex legal structure, which is expensive to set up and run. There are considerable legal and compliance requirements. There can be inflexibility, as powers are restricted by the trust deed and the law. It can be difficult to make changes to the structure once it is set up.
Should I put my family business in a trust? ›
The use of a trust for succession planning has proven beneficial for creditor protection when it comes to lawsuits and preserving company assets within the family in the case of divorce proceedings.
What is a trust Why would a business owner want these? ›
Trusts are established to provide legal protection for your assets. A trust, in the case of business owners, can be a tool that enables business owners to prevent beneficiaries and potential creditors (including previous spouses) from gaining direct access to assets within the trust.
What is the advantage of a business trust? ›
Advantages of a Business Trust
The first thing it's going to do, it's going to avoid probate when the business owner dies. So with the business trust instead of you owning your company individually, the trust is the one who owns the business.
Why use a trust instead of an LLC? ›
The answer is that the LLC is designed to protect your personal assets from lawsuits, while the Living Trust preserves your estate from probate costs and inheritance taxes when you die, and prevents court control of your assets if you become incapacitated.
What is the negative side of a trust? ›
Trusts offer amazing benefits, but they also come with potential downsides like loss of control, limited access to assets, costs, and recordkeeping difficulties.
Why are trusts considered bad for business? ›
Trusts are problematic for several reasons. Monopolies develop from trusts and give total control of a specific industry to one group of companies. Owners and top-level executives of monopolies profit greatly, but smaller businesses and companies have no chance to make money at all.
Why do rich people put their money in a trust? ›
To reduce income taxes and to shelter assets from estate and transfer taxes. To provide a vehicle for charitable giving. To avoid court-mandated probate and preserve privacy. To protect assets held in trust from beneficiaries' creditors.
- A Trustworthy Tool to Protect Your Business.
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- Grantor Retained Annuity Trust: Income & More.
- Life Insurance Trust: Taking the Tax Out of Life Insurance.
- Charitable Trusts: Altruism and Tax Breaks.
Q: How does a trust compute its income tax liability? A: A trust computes its income tax liability in much the same way that an individual does and is allowed most of the credits and deductions that an individual is allowed. Similarly, deductions not allowed to individuals are not allowed to trusts.
Why do business owners like trust? ›
trusted companies have more loyal customers, lower employee turnover, higher revenue and profitability, and higher market value. Also, higher levels of trust result in lower costs of doing business.
Is it smart to put your business in a trust? ›
Asset protection: A trust can protect your business assets from creditors and lawsuits. Estate planning: A trust can be used to transfer your business assets to your heirs without going through probate. Tax benefits: Some types of trusts, such as charitable trusts, can provide tax benefits for your business.
What is trust in business in simple words? ›
A trust is a business structure that doesn't have an owner or owners in the traditional sense. The trust imposes an obligation on the trustee – a person or a company – to hold and operate the business assets for the benefit of others, the beneficiaries.
Can a trust own an S Corp? ›
Many people ask if a trust can own S Corporation stock. In general, living trusts and testamentary trusts may hold S corporation stock only for two (2) years after the date of death of the grantor.
What is an example of a business trust? ›
Business Trusts Example
Examples of business trusts include: Example #1: Delaware and Alaska have specific state laws related to trusts in that there are special tax and financial advantages for beneficiaries. Example #2: A grantor trust allows someone to manage their business finances while providing for heirs.
What does it mean to have trust in a business? ›
trusted companies have more loyal customers, lower employee turnover, higher revenue and profitability, and higher market value. Also, higher levels of trust result in lower costs of doing business. Not least because trust makes customers recommend your company…
