How To Use Trusts For Business Succession Planning

In the last publication of our succession planning series, you learned about business succession planning for C-corps. Today, we'll pivot and discuss one important structure business owners use for succession planning—a trust. It is a fiduciary relationship where the grantor grants a trustee the right to hold property or assets for the benefit of a third party, known as a beneficiary. Today's article will expand on the concept of trusts and how business owners can use these legal entities to plan for the future of their ventures. Keep reading below.

Types of Trusts

There are different types of trusts, and while some can facilitate a smooth and comprehensive business succession plan, some are intended for a different purpose altogether. Before forming a trust to hold your assets—whether life insurance proceeds, business ownership interests, stock, or physical assets like rental property—it is essential that you speak to a legal professional.

Trusts generally fall into two broad categories based on whether the grantor retains control over the trust assets during their lifetime. Below are the two main classifications of trusts:

Revocable Living Trusts

A revocable living trust is an arrangement where you, the grantor, place assets into a trust during your lifetime. One of the biggest advantages is that it allows you to retain control over your assets and ensure a smooth transfer upon your death. Here are some features of revocable trusts that you should know about as a business owner:

• You have full control: You can serve as both the grantor and trustee, effectively retaining control over your assets.
• Revocation: You can change the terms of the trust or revoke it at any time.
• Privacy: Upon your death, the trust assets in the trust transfer to designated beneficiaries, including family members without going through probate, maintaining privacy and saving time.

Understanding the taxation aspect of revocable trusts

During your lifetime, your revocable trust is treated as a grantor trust for taxation purposes. This means you must report the income, deductions, and credits the trust assets generate on your personal tax return. The trust uses your own Social Security Number instead of a separate taxpayer identification number, and the trust itself does not pay taxes. Because the assets remain under your control and are considered part of your taxable estate, revocable trusts are generally not effective in reducing estate taxes.

Irrevocable Trusts

An irrevocable trust is created to protect the grantor's assets and minimize federal estate taxes. It is fundamentally different from a revocable trust because, by transferring assets into the trust, you, the grantor, relinquish control and ownership over those assets entirely. Assets in an irrevocable trust are managed by a trustee who is bound by a fiduciary duty to adhere to the terms of the trust agreement.

Below are features of irrevocable trusts that you should know about:

• Irrevocability: The terms of an irrevocable trust cannot be amended, altered, or revoked without the consent of the beneficiaries and sometimes a judge.
• Asset protection: Assets transferred to an irrevocable trust are no longer considered the property of the grantor. As such, they are protected from creditors, lawsuits, and divorce settlements.
• Control of distribution: Although you relinquish control over the trust assets, you can set terms that determine how the assets will be distributed to family members and future generations.
• Avoidance of probate: Assets placed in an irrevocable trust avoid probate, keeping your wealth private and saving time and costs associated with the probate process.
• Trustee management: Trust assets are managed by a trustee, who can be a family member, a trust advisor, or a professional fiduciary.
• Generation-skipping trusts: You can create generation-skipping irrevocable trusts that pass assets directly to grandchildren or beyond, bypassing the immediate generation.
• Tax benefits: Irrevocable trusts offer significant tax benefits. The value of the assets transferred to the trust is removed from your taxable estate, potentially reducing or eliminating estate taxes.

Conclusion

We have come to the end of our discussion on using trusts for business succession planning. As you've seen, these legal entities offer a myriad of tax benefits and, depending on how they are structured, flexibility in managing and transferring assets. In our next article, we'll discuss another legal tool you can use to plan for the future of your business: buy-sell agreements. We look forward to sharing more with you then.

Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.

At Wilkinson Law, we give business owners the clarity they need to fund, grow, protect, and sell their businesses. We are trustworthy business advisors keeping your business on TRACK: Trustworthy. Reliable. Available. Caring. Knowledgeable.®