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How Can Business Owners Use Trusts to Their Advantage?

Protecting your business assets is imperative, especially if you are planning for future generations to take over the business. Incorporating your business or setting up a limited liability company (LLC) provides some personal protection, but it does not protect business assets. However, setting up separate companies for separate businesses will protect one business' assets from the creditors of a second business that you own.

Setting up a trust may also help to protect your business assets. Several different types of trusts exist, and you need to choose the type of trust that best fits your situation. While you may draft your own trust, you should retain an attorney if you have extensive business assets to protect.

Trusts and Tax Protection

Currently, the “death tax” is set high enough so that most families and small businesses do not have to worry about meeting the threshold of taxation upon the owner's death; however, the tax laws could change. Even if you do not think you have enough assets to meet the threshold, which is currently just over $5 million, it is still a good idea to create a trust.

Trusts and Creditor Protection

When you set up a trust to protect your assets from creditors, you must be careful, or you could end up in a bind with a creditor accusing you of avoidance. If you set up a trust for your business at the same time you create the business, it does not look as though you only set up that trust just to avoid a creditor.

Protect Your Business

Even if you do not think you may need protection from creditors, circumstances could change, so it is always a good idea to set up protection for your business and personal assets before or at the time you set up a business.

Types of Business Trusts

Not everyone will need the same type of trust. Personal trusts and business trusts vary based on each person's circumstances. Before you choose a trust, be sure you choose the one that best benefits your business and what you see in the future for your business.

Grantor Retained Annuity Trust

If you structure your business as an S corporation, you could use a grantor retained annuity trust to transfer your business assets upon your death. The transfer would not be subject to estate taxes. The trust provides income via an annuity, which could be a percentage of the trust or a fixed amount of money, to the beneficiary named in the trust.

The beneficiary is the creator of the trust. A grantor retained annuity trust is an irrevocable trust, which means that once created, you cannot revoke it. Businesses should be careful when choosing this type of trust, as it should generate enough income to pay the beneficiary.

In some trusts, the creator does not keep control of the assets. However, with the grantor retained annuity trust the creator does keep control of the assets that are placed into the trust. Common items transferred into this trust include business shares, mutual funds, bonds, stocks, and other assets. The best assets to place in a grantor retained annuity trust are assets that you expect to appreciate.

Life Insurance Trust

If your business is worth more than the limit for estate taxes, you do not have a lot of liquid assets, and you want to pass the business to a family member, a life insurance trust might be the answer for you. For example, if your business is worth $10 million, expect to pay estate tax on anything over the deduction for the estate tax, which is just over $5 million as of 2017. If you have two children, but one is not interested in the business and you want to leave that child an equal amount, you will not be able to without liquidating the business.

To get over these hurdles, take out a life insurance policy—it is better if you have one already—and place the life insurance policy into a life insurance trust. Term life insurance is income tax free. However, that life insurance policy would be subject to the estate tax since your assets are over the deduction allowed for the estate tax. By placing the life insurance policy in a life insurance trust, you could avoid estate taxes on the life insurance policy.

The life insurance policy would pay the estate taxes and would give the other child an amount equal to the worth of the business if the policy is large enough. You could even start out with one insurance policy and gift cash to the trust to purchase more life insurance. The trust is the beneficiary and the owner of the life insurance policy.

After you die, the trust documents give the insurance policy to the beneficiaries you named in the trust and you will have enough cash to pay the estate taxes. The assets contained in the trust are also free from estate taxes. Your children will not have to liquidate the business to cover estate taxes or to split the assets so that one sibling gets an equal amount.

There are two caveats with a life insurance trust:

  • You cannot act as the trustee. The best trustee would be your bank or another financial institution.
  • The trust must be filed at least three years prior to your death, so this is not something you should create later in life.

Charitable Trusts

Choose one of two types of charitable trusts if you want to leave some money to charity and some to a family member or friends. Both types are irrevocable, so once you create them, you will not be able to change them. Choose wisely, and make sure you want the charity to receive the money. Furthermore, the charity or charities you choose must be classified as tax exempt by the Internal Revenue Service. The trustee, a financial institution or a named charity, must also keep tax records.

  • Charitable lead trust – With this type of trust, you add assets to the trust. The charitable lead trust documents specify that the charity receives money for a set period of time. The second beneficiary—it could be you or another person—receives what is left in the trust when the time frame ends.
  • Charitable remainder trust – This trust works in the exact opposite way of the charitable lead trust. Place assets into the charitable remainder trust and the beneficiary gets the income first for a specific amount of time. When the time frame is completed, a named charity gets what is left.

Types of assets for these trusts might include securities, business shares, money from the sale of the business, and other assets.

The benefits of giving some of your money to charity include reduced income, so you have less to claim on your tax return, and assets that appreciate do so faster since charities do not pay capital gains tax.

Setting Up a Living Trust for a Business

A living trust is for personal or business assets and is in place while you are still alive. Should something unexpected happen where you become unable to tend to your affairs, your family is able to continue running the business, or in the case of personal assets, are able to manage your assets for you.

When you place your business assets in a living trust, the business is able to keep running, thus it is able to support you, even though a family member is running the business. Upon your death, the assets in the trust go directly to the beneficiary, allowing the business to continue after your death should the family member choose to keep running the business. Even if your estate does need to go through probate, the assets contained within the living trust will be disbursed much quicker than assets that are not in the trust.

When you set up a living trust, you may designate yourself as the trustee, plus a secondary and tertiary trustee. That way, you remain in control of your assets for as long as you are alive. Upon your death, the secondary trustee gains control of the assets. Should something happen to that person, the tertiary trustee gains management of the assets.

A living trust for a business relieves the burden of business debts on your family members. If your business is not in a trust, business assets may be used to satisfy personal debts, and that could cause the business to fold.

The living trust also reduces the tax burden on your estate. The estate will still have to pay federal taxes, but it minimizes any state inheritance taxes. Combine the living trust with a life insurance trust to further reduce your heirs' tax liabilities.

Furthermore, you are not required to file a living trust with the courts; however, it should be signed and notarized. Be sure to place your assets into the trust. As with any estate documents, be sure the trustees and beneficiaries know where to find the documents in the event of your death or if you become unable to tend to your own affairs.

Durable Power of Attorney

Another document to have handy is a durable power of attorney. This document gives another person permission to make decisions if you are not able. This document is useful if something happens to you and you are unable to handle your own affairs. A durable power of attorney and a living trust for your business makes it very easy for the beneficiary to continue conducting business for you when you are not able.

A durable power of attorney allows the beneficiary to buy and sell real estate; make medical decisions; register, buy, and sell vehicles; pay personal and business creditors; and more, depending on the permissions you give. Should you wish the beneficiary to file bankruptcy on your behalf, you may also add language to that effect. This may come in handy should the business start to fail while you are ill and unable to take care of your own affairs.

Create the Trusts that You Need

Different types of trusts will help your heirs avoid having to liquidate the business in order to pay taxes. Your wishes are able to continue in the name of your family or friends if you set up the proper trusts for business and personal assets.

Use our forms below to create the trust that is right for you right now.