Why Every Business Owner Needs a Trust
As a business owner, it’s absolutely imperative that you protect your business assets. This is especially true if you’re planning to have future generations take over business operations. Of course, incorporating your business or setting up an LLC does provide some measure of personal protection. But it doesn’t protect your business assets.
With that said, setting up completely separate companies for different business endeavors will protect the assets of one business from another’s. But if you’re looking for the best way to protect the assets of your business, it’s time to look into setting up a trust.
There are a few different trust types available to you. Depending on the type of business you run and what your intentions are, you’ll need to choose the one that fits your specific situation.
With that said, let’s take a deep dive into business trusts and why you, as a business owner, need one.
As of today, the government has the death tax set at a high enough plateau that most small business owners and families won’t need to worry about hitting the taxation threshold if the business owner dies.
However, tax laws are always changing. Because of this, even if you don’t have enough assets to meet the current taxation threshold (which is a tick above $5 million as this article is written), it’s still smart to have trust.
Protection From Creditors
If you’re currently running your business, be careful when you set up a trust that protects assets from potential creditors. Certain creditors might put you in a bind, thinking that you set up the trust to avoid your credit obligations.
If possible, set up your trust during the same time you’re creating your business. This makes it obvious that you’re not setting it up just so you can avoid current creditors.
Types of Trusts
Business trusts are not a one-size-fits-all situation. The same holds true for personal trusts. They vary widely based on the circumstances and needs of each individual or business.
Before choosing a trust, ensure that you’re choosing the one that will benefit your business the most, both now and in the future.
In order for you to make the best decision, let’s take a closer look at some of the available trusts you have to work with.
Grantor Retained Annuity Trust
This trust can be used for business owners that have incorporated as an S Corp. It allows you to have your business assets transferred in the event of your death. What’s best, this transfer isn’t subject to any estate taxes whatsoever.
This type of trust provides a regular annuity income to the beneficiary that’s named. The amount the annuity pays could be a fixed amount or a certain percentage of the trust.
The individual who creates the trust is named the beneficiary. This trust is a type that irrevocable. As a business owner, take caution when you choose this type of trust for your business. In most cases, it should generate sufficient income to pay the named beneficiary.
In some types of trusts, the trust creator doesn’t retain control of the business assets. With a Grantor Retained Annuity Trust, however, the creator does, in fact, keep asset control.
Some of the most common assets that get transferred into a Grantor Retained Annuity Trust include:
- Business shares
- Mutual funds
- Other financial assets
You’ll want to place assets that you anticipate will appreciate in value into this type of trust.
Life Insurance Trust
This is the type of trust you’ll want to choose if you don’t have a lot of liquid assets, you intend on passing your business down to a member of your family, or the value of your business exceeds the limit for estate taxes.
Let’s look at an example. Say that your total business value is $20 million. Currently, the deduction for estate taxes sits at $5 million. That means you would expect to pay an estate tax for the remaining $15 million of the value of your business.
If you have three children and two of them aren’t interested in running your business, but you still want to leave them an equal amount as the one who does want to run it, you’ll need to liquidate your business in order to do so.
To overcome this obvious hurdle, you’ll need to take out a life insurance policy (even better if you already have one) and place the policy into your life insurance trust.
Keep in mind that term life insurance is always tax-free. Unfortunately, the policy will be subject to estate taxes because your assets exceed the standard deduction allowed by the estate tax. When you place your policy into a life insurance trust, it helps you avoid the estate taxes on the policy.
The trust will allow the life insurance policy to pay all estate taxes owed while giving the children who don’t want to be involved with the business an equal amount of what the business is worth. Of course, the life insurance policy will have to be large enough to support this.
Another option is, to begin with, a single insurance policy and gift cash to your trust in order to buy more life insurance. This is allowed because the trust is the actual beneficiary and owner of the policy.
Upon your death, the documents of the trusted hand over the insurance policy to the named beneficiaries while retaining enough money to pay off all estate taxes. What’s more, the assets named in the trust are completely free from all estate taxes.
This allows your children to avoid unnecessary liquidation of your business in order to cover the estate taxes or split assets to ensure each child gets an equal amount of money.
There are, however, two major caveats with life insurance trusts:
1. You are not allowed to act as a trustee. You’ll need to choose a bank or other financial institution to act as a trustee.
2. This is not a trust you want to set up in your later years of life. The trust must be filed at least three years before you die.
There are two different types of charitable trusts. Choose one of these if you’d like to leave some money to a charity along with your family members or friends.
Understand that both charitable trust types are irrevocable. Once they’re created, they can’t be changed. Choose your charity wisely and make sure it’s the charity you wish to receive your money.
Keep in mind that the charities you choose have to be classified tax-exempt by the IRS. The trustee, a named charity, bank, or financial institution, has to keep all tax records.
The two types of charitable trusts are:
Charitable lead trust
: You add assets to this type of trust. The documents of the trust specify that the charity of choice receives the payout for a given period of time. The second beneficiary, whether it’s you or another individual, receives what’s left within the trust once that time frame is over.
Charitable remainder trust
: This option works in the complete opposite way as the charitable lead trust. In it, you place assets and the named beneficiary gets the first income from the trust for a given period of time. When that time expires, the named charity gets what’s left.
The types of assets you’d put into a charitable trust include:
- Business shares
- Money from selling the business
- Additional assets
One of the major benefits of giving a portion of your money to a charity includes reduced income. You’ll have less money to claim on your tax returns. Also, assets will appreciate faster because charities never pay capital gains taxes.
Creating a Business Living Trust
A living trust is for business or personal assets. It’s put in place while you remain living. Should an occurrence happen that no longer allows you to tend to your own affairs, your family can keep running your business. When it comes to personal assets, your family members can manage them for you as well.
A living trust allows your business to continue to support you by keeping the business running even though you’re no longer able to operate it. When you die, all assets within the trust go to the beneficiary. This allows the business to continue on after you die, should the family member running it decide that they would like to continue.
Even in the unfortunate situation where your estate needs to go through the probate process, assets within the living trust will be disbursed a lot faster than assets outside of the trust.
When setting up your living trust, you’re allowed to assign yourself as a trustee. You can also add secondary and tertiary trustees. Because of this, you’ll stay in complete control of all assets for as long as you remain alive. Upon your death, your secondary trustee will gain control of all assets. Should something unfortunate happen to them, your tertiary trustee gains asset management rights.
The best feature of a living trust for business is that it completely relieves any burden of business debt from members of your family. It also reduces your estate’s tax burden. Yes, the estate will have to pay federal taxes, but it works to minimize state inheritance taxes, which can be hefty.
Durable POA (Power of Attorney)
An additional document you’ll want to have in hand is the durable POA. This is a document that gives someone else full permission to make decisions for you in the event that you’re not able to do so. It’s useful if tragedy strikes and you can’t handle your own affairs.
A durable POA, coupled with a living trust for business, makes it simple for your beneficiary to continue running your business if you can’t.
With a durable POA in place, your beneficiary will be allowed to:
- Buy, register and sell vehicles
- Pay business creditors
- Pay personal creditors
- Access necessary bank accounts
These are all based on the permissions you give in the durable POA. In the event that you’re no longer able to perform normal functions, they may also file bankruptcy on your behalf, as long as a language to that effect is added to the document.
Why Your Business Needs a Trust
The different types of trusts available will assist your heirs in avoiding business liquidation and over-the-top taxes. Your personal wishes will continue on in the name of family or friends when you set up the right trusts for your business and personal assets.