Closely-held businesses come in all shapes and sizes. Some owners own 100% of their businesses. Some have partners. Some have children in the business. Some do not. A common question that a client asks the business and tax planning professional is, “Should I own my business in a trust?” There are, of course, many nuances to this question, and every situation is different. Nonetheless, below are some important considerations in evaluating the benefits of having a trust own a portion of the equity in a business.
Control. Business succession planning involves both management succession – that is, who runs the business and ownership succession – that is, who owns the business. Sometimes, transferring a portion of the equity of the business to a trust ensures that the family continues to own the business (even if non-family members run the business). We often will recapitalize a company so that there is a voting interest which controls all business decisions, and a non-voting interest which represents the economic interest in the business. An owner may transfer the non-voting interest to a trust and maintain control by keeping the voting interest in his or her name.
Cash flow to surviving spouse. A common concern with business succession planning is providing cash flow to a surviving spouse. Having a trust own a portion of the business can help address this. The trustee could be the surviving spouse, either alone or with one or more co-trustees. The trustees can use their discretion to receive cash flow from the business and make trust distributions for the surviving spouse’s support.
Equalization among children, or reward to child in the business. A trust can provide for the benefit of one or more children. If cash flow from the business flows into the trust, the trustees then can use their discretion to make distributions to (1) a child who is in the business, or (2) a group of children who are not in the business. A trust can provide the client with great flexibility to address the family goals in this context.
Estate tax. The business owner may make a gift of a non-voting interest in the business to a trust for the benefit of the family. The gift removes the value of the asset from the business owner’s taxable estate, and may save estate taxes in the future upon the business owner’s death. All future appreciation in the value of the business may be removed from the business owner’s estate. In addition, the value of the gift may be discounted due to lack of control and lack of marketability.
Because of a concern that the federal estate tax exemption – currently $11.7 million per person – will be reduced in 2026 or earlier, many business owners with potential estate tax issues should consider this type of gift prior to a change in the law.
Asset protection. Assets gifted to a trust are no longer owned by the business owner, and may be protected from his or her potential creditors. Assets left to children in trust rather than outright may be protected from the child’s potential creditors. In this way, trust ownership can provide a substantial benefit to the family.
Income tax. A trust can be used as an income tax planning tool. If, for example, trust income is distributed among three children, the income may be taxed at lower income tax rates. Trusts also may be structured in a way that produces state income tax savings.
People fail to plan all the time. One of the latest examples is Tony Hsieh, the longtime CEO of Zappos, who died unexpectedly in November, 2020, at age 46. Mr. Hsieh had a large estate, including a number of business interests and over 100 properties in Las Vegas. He had no estate planning documents in place at his death, nor any business succession planning. It is likely that the estate will owe substantial estate taxes and there will be litigation for years to come.
Business owners should be sure that their business planning, including business structure, succession and tax planning, is up-to-date and reflects their wishes. Every family business is unique, but having a portion of a business owned in a trust for the family’s benefit often has a number of advantages.