Business Trusts: What are They & How Do They Work?

 
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If you’re about to launch a new venture, you may be contemplating different business structures—but have you considered a business trust? 

A business trust allows you to hold your business in a trust instead of a traditional entity like an LLC or corporation. It works similarly to an individual or family trust by authorizing a trustee to manage the trust on behalf of the beneficiary/ies. A business can be owned by multiple trusts and entities or just one.

So, what’s the point? There are several advantages, such as tax benefits and liability protection, but these rules vary by state. Let’s take a closer look at how it works, the types of business trusts, and the pros and cons to contemplate as you form your new business.

How Does a Business Trust Work?

A business trust is a legal entity created to hold and manage income-generating assets or businesses. It is treated like a corporation and may carry out business transactions like individuals do. A business trust is formed with a declaration of trust, which generally includes:

  • Terms of the trust

  • Trustee instructions and responsibilities

  • Valid length of the trust

  • Duties, powers, and interests of the beneficiaries 

The trustee can be a company but is usually an individual (including the business’s owner). They are responsible for managing the trust’s operations, investments, and distributions to beneficiaries and have a fiduciary duty to act in the best interest of the beneficiaries. The trustee usually makes distributions on a monthly or quarterly schedule.

As the business owner, you can be the sole trustee of the business trust and be a trust beneficiary—but you may not be the only one! Beneficiaries of a business trust are typically investors or shareholders. If you run a family business, your heirs may be the beneficiaries.

Are There Different Types of Business Trusts?

Yep! Like individual and family trusts, there are three main types of business trusts. Let’s break them down.

Grantor Trust

This type of business trust involves a grantor, trustee, and beneficiary. The grantor is the individual who creates the trust, controls income and distributions, and pays taxes on it. The grantor and trust are not viewed as separate tax entities. 

Simple Trust

A simple trust must meet specific IRS qualifications. In this scenario, the trustee may not accumulate income and must issue all profits directly to the beneficiaries, who must pay taxes on any income they receive. Simple trusts may not distribute the principal amount or make charitable donations. However, they can deduct certain expenses and must file a tax return.

Complex Trust

If a simple trust doesn’t meet IRS eligibility, it may be reclassified as a complex trust. A complex trust can accumulate income, distribute amounts other than income, make charitable donations, and take charitable deductions. It must file a tax return and can deduct certain expenses. 

Revocable vs. Irrevocable Business Trusts

A business trust can be either:

  • Revocable: Also known as a living trust, this gives the grantor complete control over the trust and its assets during their lifetime. That means the grantor can change the trust, amend it, or even dissolve it at any time without the need for consent from the beneficiaries.

  • Irrevocable: An irrevocable trust does not offer the flexibility of a revocable trust. Once it is established, the grantor generally gives up control and ownership of the assets placed in the trust. The terms and distribution of the trust are typically set and can’t be changed without the beneficiaries' consent and sometimes even court approval. However, an irrevocable trust protects assets because assets are no longer considered part of the grantor’s estate.

Advantages & Disadvantages of Business Trusts

A business trust may offer several liability and operational benefits over standard business entity structures, such as: 

  • Tax Benefits: Trusts are not subject to corporate income tax and can reduce or even eliminate estate taxes.

  • Business Continuity: If the owner dies or becomes incapacitated, the business can continue operating and avoid probate.

  • Asset Protection: Separating business assets from personal assets (like an LLC does) shields assets from creditors.

  • Privacy: A business trust doesn’t have to submit public filings.

  • Easy Formation: Forming a business trust is often more straightforward than business structures like corporations.

However, a business trust can create some disadvantages, including: 

  • Cost: You’ll need an attorney to establish a trust and will likely want to retain their services to ensure effective operation.

  • Legal Complications: Business trusts are subject to tricky compliance obstacles.

  • Fiduciary Responsibility: This relationship between the trustee and beneficiaries can be more challenging than the duties required by a traditional business entity. 

  • Limited Lifetime: Business trusts are usually limited to lifespans of 99 years, taking multi-generational succession plans off the table.

Is a Business Trust Right for My Venture?

If you’re considering starting your own business and debating how to set it up, we recommend consulting with legal and financial advisors about business trusts and which type would best suit your needs! As you do, consider: 

  • Income Generation: Business trusts are most suitable for businesses with consistent income streams that can be distributed to shareholders. 

  • Tax Considerations: Evaluate the tax advantages and implications of using a business trust for your business with a tax professional.

  • Investor Preference: Are your potential investors seeking income? Will a trust structure align with their goals? 

  • Regulatory Environment: Be aware of the tax laws in your jurisdiction, which can impact the feasibility of a business trust structure. 

Are you ready to start talking business trusts with a diverse team of tax and accounting pros? Contact JLS Accounting today to find out how we can guide you. We aim to help small business owners set up their passions correctly and effectively from Day 1!