We’ll explain what a business trust is, how it operates, its benefits and drawbacks, how to set one up, and some examples of business trusts in this post.
Although trusts are typically used in estate planning, they can also be used in business operations. As a small business owner, you can hold the company in a trust rather than using a legal structure like a corporation or limited liability company (LLC). Comparing business trusts to a conventional business structure, there are a number of potential advantages and disadvantages. You can determine whether a trust makes sense for your company by being aware of its benefits and drawbacks, its various forms, and its legal ramifications.
What is a Business Trust?
A business trust and an individual or family trust function similarly. It aids in giving a trustee, who oversees the trust and its assets on behalf of the grantor, control of the assets. In contrast to business trusts, which hold the rights to an individual’s ownership interest in a company, individual trusts typically hold assets like money or real estate. Consequently, the legal entity that actually owns a business can be a business trust.
A business trust may have one or more beneficiaries. One trust or entity may own a business, or there may be several. Due to the fact that trusts frequently have different legal protections than individuals do, they are primarily used to protect against taxes and liability. But each state may have its own unique set of regulations.
How Does a Business Trust Work?
A business trust is a contract. A conversation between the parties involved and a trust lawyer who can help define the agreement’s terms then typically kicks off the process of creating one. Next, a document known as a declaration of trust is used to formally establish the trust.
The declaration of trust outlines the conditions of the trust and assigns the trustee duties and instructions. The trust’s legal duration as well as the responsibilities, authority, and interests of the beneficiaries are just a few examples. The trust is formally established when the terms are agreed upon and the declaration is signed by the trust owner.
A business trust’s trustee has a fiduciary obligation to act in the trust’s beneficiaries’ best interests. The same fiduciary duty that governs other financial situations also applies here. Most significantly, financial advisors who are registered with the SEC are bound by a fiduciary duty to act in their clients’ best interests.
The trustee is the party in charge of the trust’s business interest. Usually, a business trust is administered by a single person. The business interests pass to the trust’s beneficiaries at the end of its term. As corporations, business trusts are able to transact business in the same ways as individuals.
Business Trusts Example
Examples of business trusts include:
- Example #1: Delaware and Alaska have particular state laws governing trusts, which give beneficiaries special tax and financial benefits.
- Example #2: Using a grantor trust, a person can manage their company’s finances while also taking care of their heirs.
- Example #3: Simple trusts are a good option for parent corporations that do not have direct managerial control over the business trust.
- Example #4: Complex trusts can be used for parent corporations that do not meet the requirements for simple trusts.
- Example #5: You want to make sure you can maintain services in the event that you are unable to run your company.
As you can see, business trusts are crucial for both protecting our assets and running a successful business. When establishing this kind of entity, discuss all of your options with insurance lawyers or trust lawyers. Under the trust laws of your state, he or she can carry out your legal paperwork while also giving you ongoing legal counsel.
Types of Business Trusts
There are three main categories of business trusts, just as there are numerous different types of individual trusts. Here’s a breakdown of each:
A grantor trust is the first kind. Grantor trusts have a grantor, a trustee, and a beneficiary. It is very self-contained to have this kind of trust. The grantor has complete control over the trust and is responsible for paying taxes on its income. Control over beneficiary business distributions is a part of this.
A straightforward trust is the next step. The IRS must confirm a trust’s status before it can be included in this group. In a simple trust, the trustee must give the beneficiaries a direct share of any business profits. Additionally, actions like touching any major assets are forbidden.
Although it still isn’t managed by the trust’s beneficiaries, a complex trust is in some ways the antithesis of a simple trust. Business gains and other funds may be distributed to beneficiaries only in part or even donated to other groups, like charities. The trust must generate at least some income in order to continue to qualify as a complex trust.
Pros and Cons of Business Trusts
Business trusts have a number of benefits and drawbacks. Before committing to an organization of this kind, you should carefully consider your opportunities and obligations because the drawbacks might not apply in all circumstances. Before accepting the conditions, carefully weigh the benefits and drawbacks of business trusts.
Advantages of Business Trusts
- Advantage #1: There is a limited liability when appointing a corporate trustee
- Advantage #2: The business trust structure provides greater privacy than a traditional structure
- Advantage #3: The distributions to beneficiaries are generally flexible
Disadvantages of Business Trusts
- Disadvantage #1: Business trusts are expensive to establish and maintain
- Disadvantage #2: Legal compliance with business trusts is challenging to achieve
- Disadvantage #3: Business trusts have a limited life with a general cap of 99 years
Business trust has a wide range of benefits and drawbacks. This kind of entity should only be created if you fully comprehend how it operates. Regardless of your level of familiarity, trust lawyers are ready to guide you through the difficulties of business trusts.
Business Trusts Taxation
For the purposes of federal income taxes and other state income tax laws, business trusts are taxed in a manner similar to corporations. Trustees who oversee a business trust have a financial incentive to act in the interests of the beneficiaries. The business’s revenue and expenses are split equally among them.
Business Trusts Vs. Family Trusts
When a family’s assets are held to run a family business, family trusts are used. They provide capital and income to benefit the entire family as well as tax and financial benefits to specific family members. Family trusts may also be used in conjunction with special needs trusts or living trusts.
Business trusts are established for people who might or might not be related to the beneficiaries. They are also held for the advantage of a company or person connected to the company.
How to Set Up a Business Trust
Consult with a qualified attorney as soon as possible if you’re interested in creating a business trust. As mentioned above, you’ll probably need to work with a lawyer throughout the duration of your business trust. Be aware that the up-front cost to establish a business trust could be higher than $5,000 and that trust lawyers typically bill at a rate of around $500 per hour.
The challenging part will have been completed once the trust is operational. Even though you might need to modify the trust in the future, you must specify some of the most crucial clauses, like the trustees, beneficiaries, and distribution schedules.
Bottom Line: Trust in Business
Considering that a trust differs from other business structures in terms of advantages and disadvantages, it’s crucial to seek legal counsel early on to determine which business structure will work best for your operation.
What Does Trust Mean in Business?
A trust is a business structure that doesn’t have an owner or owners in the traditional sense. The trustee—a person or a business—is required by the trust to hold and manage the business assets for the advantage of the beneficiaries.
What is the Purpose of the Trust?
A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. A trust can specify exactly how and when the assets pass to the beneficiaries and can be set up in a variety of ways.
Why Use a Trust Instead of An LLC?
Depending on the circumstances, an LLC or trust may be chosen. LLCs are more effective at shielding corporate assets from legal liability and creditors. Trusts can handle many types of assets and are better at avoiding probate and reducing estate taxes.