Can trusts play a role in a business owner’s planning? In many cases the answer to this question is a resounding YES!
By way of background, a trust is a legal entity that holds assets for the benefit of one or more individuals or charities. These individuals or charities are referred to as beneficiaries. The trustee of a trust has the responsibility to act in the best interest of the beneficiaries in carrying out the terms of the trust. The settlor of a trust is the individual who creates the trust and transfers property to it. It is not unusual in some trusts for the same individual to carry out two and perhaps all three of those positions.
In general, there are two types of trusts. A revocable trust can be amended or terminated at any time by the settlor. As a business owner, this can help you avoid going through probate with any assets, if the trust has the same name as the business. As a business owner, you can be the settlor, trustee and beneficiary of a revocable trust when initially established, thereby maintaining full control of it. However, the terms of the trust can provide for trustee succession upon the incapacity of the business owner. It’s important to know that a revocable trust does not avoid income or estate taxes for the business owner.
The second type of trust is an irrevocable trust. Most often irrevocable trusts revolve around gifting with the goal of reducing your future estate tax liability. There are many types of irrevocable trusts you can research with the help of your advisers.
Irrevocable trusts can provide business owners with a blend of estate tax reduction strategies and protecting the beneficiaries of such trusts from creditors. Certain trusts can be structured so that the settlor continues to pay income taxes on it, which keeps the trust itself from being diminished. Sometimes an irrevocable trust may be structured to provide funding for future estate taxes while avoiding estate and income taxes on those funds, which can be beneficial to you as a business owner.
Another type of irrevocable trust that has become very popular among business owners, particularly during this season of low interest rates, is the Grantor Retained Annuity Trust (GRAT).
A GRAT permits the settlor to receive an annuity for a specific period of years. At the end of that period, the trust assets will solely benefit the beneficiary that the business owner named when the trust was created. The annuity received is expressed as a percentage of the value of the assets initially contributed to the trust. A GRAT can be an outstanding planning technique for an owner of a business that has appreciation potential and produces reasonably steady cash flow.
What makes the GRAT technique so popular is that the gift tax value for tax law purposes is determined not only by the value of the assets contributed to the trust but also based on other inputs. Those include the term of the annuity period, the percentage rate of the annuity and IRS published interest rates, which are currently at historic lows. Once the gift value is reported in the year the GRAT is funded, there are no further gift implications to the GRAT even if the trust assets appreciate significantly over the annuity term and are much more valuable when the beneficiary benefits from them.
Irrevocable trusts can also be used to assist a business owner with charitable intentions. These trusts most frequently take the form of Charitable Remainder Trusts (CRT) and Charitable Lead Trusts (CLT). Using the CRT the settlor receives an annuity for a period of years or even life with a charity or charities receiving the trust assets afterward. With a CLT, the designated charity receives an annuity for a term of years and at the end of that time period a non-charitable beneficiary (even the settlor) can take possession of the remaining assets.
Trusts can serve a valuable role for a business owner but they are not a fit for everyone. A strong advisory team including an attorney, CPA and financial adviser can help a business owner sort through the many types of trusts that may be advantageous to his or her planning.
Tom Williams is CEO, partner and senior wealth adviser at Domani Wealth.