Table of Contents Hide
- What is a Business Trust?
- How Does a Business Trust Work?
- Types of Business Trust
- How to Set Up a Business Trust
- Taxation of Business Trust
- Family Trusts vs. Business Trusts
- What are the Costs of Establishing Business Trusts?
- What Are the Benefits and Drawbacks of a Business Trusts?
- Corporation vs. Business Trusts
- Business Trust vs. Limited Liability Company
- Last Thoughts
- Business Trust FAQs
- How do I open a trust for my business?
- Why do businesses have trusts?
- Do trusts pay taxes?
The great majority of business owners conduct their company as a corporation or a limited liability company (LLC). Corporations and LLCs are both good business solutions since they provide limited liability and are distinct from their owners. However, while being a lesser-known option, business trusts are an equally good choice.
While business trusts have the same restricted liability and function as separate companies to conduct business, they differ considerably in three ways: they provide a better level of privacy, need less compliance, and serve as an excellent estate planning tool. This post will explain what a business trust is, how to set it up, and how to use one.
What is a Business Trust?
A business trust is also known as a Massachusetts trust or a common law trust. The formation and structure of a business trust are akin to other similar structures. Trusts are real estate or assets, or both, that are managed by someone appointed to manage the beneficiary’s interest. The trustee is an appointed individual, while the settler is the person who owns the property under the trust. The trustee’s function is to administer the trust for the benefit of the beneficiaries, and the beneficiaries are the ones who have equitable ownership of the trust.
How Does a Business Trust Work?
A trust is an agreement in which one party, known as the trustee, agrees to keep, administer, and direct funds or property on behalf of another person, known as the beneficiary.
A trustee runs a business and performs transactions for the benefit of its beneficiaries in a business trust. The trustee, who can be a corporation or an individual (including the owner of the business), can be empowered to distribute business revenue and transfer property to beneficiaries.
As long as the business owner is not the sole beneficiary, the business owner can be the sole trustee of the trust that holds the business. A business trust’s beneficiaries are typically investors or stockholders. If it is a family business, the heirs of the owner may be the beneficiaries.
Types of Business Trust
There are three primary types of business trusts, just as there are various types of individual trusts. Here’s an explanation for each:
#1. The Grantor Trust
A grantor trust is the first type. Grantor trusts include three components: a grantor, a trustee, and a beneficiary. This kind of trust is self-contained. The grantor pays taxes on the trust’s income and has complete control over it. Control over business distributions to beneficiaries is included.
#2. Simple trust
Following that is a simple trust. The IRS must verify the status of trust for it to fall into this category. The trustee of a simple trust must pay business profits directly to the beneficiaries. It is also forbidden to do things like touch any major assets.
#3. Complex Trust
A complex trust is similar to a basic trust in certain aspects, but it is still not controlled by the trust’s beneficiaries. Profits from businesses and other sources may be allocated only partially to beneficiaries and may even be donated to other groups, such as charity. The trust must have some form of income to maintain its position as a complex trust.
How to Set Up a Business Trust
If you want to set up a business trust, the first step is to speak with an attorney who can assist you. As previously said, you will almost certainly need to deal with an attorney during the life of your business trust. It should be noted that trust lawyers normally charge around $500 per hour, and the total cost of establishing a business trust might be around $5,000.
The hardest part is officially over once the trust is up and running. While the trust may need to be amended in the future, you must explain some of the most critical elements, such as payout schedules, trustees, and beneficiaries.
Taxation of Business Trust
In terms of federal income taxes and other state income tax legislation, business trusts are taxed similarly to corporations. Because trustees manage a business trust, they have a financial obligation to operate in the best interests of the beneficiaries. Profit and loss generated by the business are allocated equally among them.
Family Trusts vs. Business Trusts
When a family’s assets are held to manage a family business, a family trust is employed. They provide capital and revenue to the entire family while providing tax and financial benefits to individual family members. Family trusts can also be used in conjunction with living trusts or a special needs trust.
Business trusts are established for individuals who may or may not be related. They are also held for the benefit of a business or an individual associated with the business.
What are the Costs of Establishing Business Trusts?
The price of establishing business trusts will vary depending on your circumstances. Trust lawyers often charge between $250 and $500 per hour and a minimum of $1,000 to establish a simple business trust. However, the expense of establishing a business trust could be $5,000 or more.
The following factors may set your costs for establishing a business trust:
- You have a complex business structure or multiple assets.
- There are numerous beneficiaries involved.
- Planning for specific beneficiaries is more difficult than standard matters.
- Other types of trusts are required to fulfill personal needs.
- Other types of contracts are being written to satisfy business needs as well.
- Requiring further legal counsel on similar matters
- Requesting continuing management of the business trust
- Attending hearings or civil court proceedings on your behalf
It is also feasible to employ trust lawyers to act as trustees rather than identify the business or yourself. Trust lawyers can handle business trusts regularly, but this option will greatly increase their prices.
What Are the Benefits and Drawbacks of a Business Trusts?
Depending on the sort of trust established, business trusts may have the following benefits over regular business structures:
- Probate avoidance upon the death of the business owner
- Estate taxes should be reduced or eliminated.
- When the proprietor dies or becomes incompetent, the business continues.
- Separation of business and personal assets (similar to an LLC)
- A business trust provides more anonymity than an LLC because public filings are not required.
- Asset protection from creditors
- The formation process is less complicated than that of some standard business forms.
Business trusts can also be complicated by the following factors:
- Ongoing expenses to maintain trust (e.g., paying a third party to manage it)
- Defying legal regulations (e.g., the IRS does not recognize a business trust as a type of business organization)
- The trustee-beneficiary fiduciary relationship requires the former to behave in the best interests of the latter and may differ from the duties needed in a conventional business structure.
Corporation vs. Business Trusts
A business trust was created many years ago to avoid limits on real estate development and company acquisitions while retaining the desirable limited liability feature of a corporation. Business trusts differ from corporations in that their status is derived from the voluntary actions of the people who form them. No state charter gives it legal standing.
In some states, business trusts must follow trust law, whilst in others, the laws of companies or partnerships control their existence. In states that treat trusts as partnerships, the beneficiaries would be held accountable for specific components of the business. Beneficiaries of a business trust have restricted responsibility in general. If the state treats a business trust as a partnership, the beneficiaries may be held completely accountable for any judgments rendered against the trust.
Business Trust vs. Limited Liability Company
Most experts, however, recommend that you explore further preserving your assets by forming a business trust or a limited liability company (LLC). Creating a legal corporation to operate on your behalf for investments is a risk-management approach. (Yes, the Internal Revenue Service (IRS) permits this method.)
There are numerous advantages to using a business trust or LLC. Business trusts, on the other hand, go beyond the safeguards provided by an LLC.
Personal Privacy Protection
There is no legal obligation that you file your business trust publicly. Your trust agreement, or Declaration of Trust, is likewise secret. Trustee names, addresses, and other personal details about your business trust are all regarded as private and are not automatically published. This is not the case with LLCs. When you form an LLC, you must register not only the Articles of Organization with the Secretary of State in your state but also your name and address, as well as the management of the business.
Personal Liability is Reduced
When you invest through a business trust, all investments and gains are legally separated from your assets. This is advantageous for two reasons. If you utilize your business trust to invest in a property and default on the loan, this separation will shield your assets from any legal consequences. However, if you declare personal bankruptcy, your business trust assets are shielded from the proceedings. Personal liability is limited in the case of an LLC. Furthermore, these safeguards are only in effect as long as your LLC conforms with legislation. All annual filings, fees, and procedures must be met or you will lose this protection and the asset separation will be null and void.
A Simple Structure
A business trust is reasonably easy to set up. There are no set costs or annual fees associated with their creation. They are not subject to approvals, registrations, or other factors that can cause setup to take time because they do not require public filing. In comparison, forming an LLC is a little more difficult. LLCs require name reservations, application approvals, and waiting periods. They also have some expensive government filing fees that are necessary at start-up and every year (or biennially). LLCs are also required to file reports with the Secretary of State per their state’s statute. After all, is said and done, it can take one to three months for an LLC to officially finish the approval process and become a legal company that can be used for investments.
Taxation and a Disregarded Entity
You can file taxes as a partnership or corporation with both business trusts and LLCs. A business trust, on the other hand, permits you to file as a trust. A limited liability company will allow for personal filing. When you establish your business trust or LLC as a partnership, you must file federal and state income tax returns. If a partnership has only one owner, it can be “considered as an entity apart from its owner.” When this occurs, the entity is exempt from filing certain income tax returns. Being a “disregarded entity” for business trusts means you won’t have to file a federal or state tax return. However, most states will still require you to file income tax returns for LLCs.
Investing in real estate is one of the most prevalent SDIRA techniques. If you are an LLC and want to invest in properties outside of your state, you must first form your company in that state and go through the established processes. You will very certainly need to engage an agent in that state to operate as their manager as well. This process and any associated fees do not apply to business trust investments.
A business trust is often difficult to set up, and it is not a required component of every business. Your current business form may be adequate, or you may benefit from the use of a limited liability corporation (LLC), a partnership, or another type of structure. Before you begin the process of establishing a business trust, you must first identify the main aspects that will surround it.
Business Trust FAQs
How do I open a trust for my business?
To open a business trust, check the papers necessary by the bank where the account will be opened. Although each bank’s requirements vary, the trust agreement or document that establishes the trust and appoints the trustee, as well as two forms of personal identification are usually required.
Why do businesses have trusts?
A trust business structure, in addition to asset protection, allows for tax planning. This is to reduce the amount of tax payable on distributed income or capital, the trustee can distribute income to the beneficiaries at the lowest marginal tax rates.
Do trusts pay taxes?
Yes, whether the trust is simple or complex, the trustee is required to file a tax return for the trust (IRS Form 1041) if the trust has any taxable income (gross income minus deductions is greater than $0) or gross income of $600 or more. It depends on the grantor’s trust.