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.

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.