If you’ve made the decision to incorporate your business or reevaluate the existing entity, it’s crucial to not only select the appropriate business structure but also determine who or what should own that entity. Often overlooked by many basic business lawyers, this question is of paramount importance in facing risks such as incapacity, divorce, bankruptcy, and death.
Considering that death is an inevitable reality, it is prudent to have your business interests owned within a Revocable Living Trust. This holds true irrespective of whether your business is structured as a limited liability company (LLC), corporation, or partnership.
Revocable Living Trust
A Revocable Living Trust serves as the custodian of your business assets. In the event of your incapacity or demise, your Successor Trustee can seamlessly take charge without the necessity for court intervention. As the Trust is revocable, it involves no separate tax ID, no tax implications, and minimal tasks, requiring only the creation of the Trust agreement and the reassignment of your business ownership to the Trust. When properly facilitated by a lawyer like us, well-versed in ensuring accurate decisions and drafting, establishing Living Trusts is a straightforward process.
However, one limitation of a Living Trust is the absence of protection against creditors, divorce, or estate taxes. If your business is not anticipated to have substantial future value, merely serving as a source of income for you without the potential of earning millions, owning it within a Revocable Living Trust might be acceptable.
Yet, if your business has the potential to be worth millions, it is advisable to explore the option of holding the business in an Irrevocable Trust.
Irrevocable Trusts
Under an Irrevocable Trust, the business is owned by the trust, not by you. Shielded from what you don’t own, creditors and legal actions cannot reach your company and its assets when held within such a Trust. Additionally, if substantial growth in the business’ value is anticipated, an Irrevocable Trust can offer protection against estate taxes.
An Irrevocable Trust possesses its own tax ID number, and the Trust is regarded as a distinct taxpayer from you. By designating the Trustee of the Trust as the business owner and having an Independent Trustee involved, an additional layer of asset protection and safeguarding against estate taxes is established.
In essence, if your business is envisioned to endure for your lifetime, ownership by yourself, or at least your share, within a Revocable Living Trust is reasonable and advisable. Conversely, if you are building a business with the potential of becoming highly valuable or wish to bequeath the business and its substantial worth to your loved ones, it is prudent to contemplate having the business owned within an Irrevocable Trust, not in your name.
So, why would you refrain from owning your business in your name? Ownership in your name introduces various risks, particularly liability and tax implications.
Risks of Owning a Business in Your Name: Liability and Taxes
If your business is registered in your name and you encounter personal issues or go through a divorce, your business might be seized to satisfy a judgment against you. For instance, in a divorce settlement, it could necessitate purchasing half of your law firm, as in the case of Ali Katz, the founder and CEO of New Law Business Model.
An alternative example involves an individual named Anthony, who, during a stay at a friend’s penthouse, inadvertently caused significant water damage due to a running bath. Despite insurance coverage for the damages, the insurance company sought reimbursement from Anthony through “subrogation.” In the presence of valuable assets or a business owned by Anthony, the insurance company would have pursued legal action, potentially resulting in a judgment against him.
Protecting your business from such liabilities is a compelling reason not to own it in your name—applicable to businesses of any value. As mentioned earlier, for businesses with substantial potential future value, ownership within an Irrevocable Trust is worth considering.
Another factor favoring ownership within an Irrevocable Trust is the potential estate tax burden upon death. With the 2023 estate tax exemption set at $12.92 million per individual, surpassing this threshold attracts a 40% estate tax. If your business holds high value, it is likely to exceed this limit, leading to significant estate taxes for your loved ones.
Furthermore, the estate tax rate is subject to change based on the governing administration, and certain states impose lower estate tax exemptions. For instance, Massachusetts imposes estate taxes on estates valued over $1 million. Without adequate protection planning for your business, your loved ones may incur unnecessary expenses following your demise.
By establishing your business within an Irrevocable Trust, the business’s value is positioned outside your estate for estate tax calculations. This strategic move prevents your loved ones from shouldering substantial taxes post your demise. Additionally, an Irrevocable Trust provides protection against liabilities such as creditors, lawsuits, divorce, and bankruptcy.
Seek Our Assistance to Safeguard Your Business
If your business currently bears your name, there might still be an opportunity to transfer it into an Irrevocable Trust structure. However, it is crucial to seek guidance from a dependable Estate and Succession Planning Attorney like us, well-versed in these structures, to ensure proper setup. Considering the unpredictability of incapacity and death, taking prompt action is highly advisable.
For those considering the establishment of a business projected to accumulate significant worth in the future, get in touch with us, your Family Wealth and Estate Attorney with business planning expertise, before embarking on the incorporation process. We can assist in establishing an Irrevocable Trust to furnish your business with robust protection against asset and estate taxes through legal planning. If you require the establishment of a Revocable Living Trust for your business, we are well-prepared to assist with that as well. Connect with us today to initiate the process.
This article is presented by Michelle Bell, an expert in estate planning and business succession services. Our office provides comprehensive legal support for businesses, assisting you in making informed decisions throughout your entrepreneurial journey and in planning for future contingencies. We also offer a specialized session where we review your business’s legal structures. To arrange this consultation, please click the following link: https://calendly.com/mcblawpllc/30min.
The information in this article is intended purely for educational and informational use and should not be considered as advice on ERISA, tax, legal, or investment matters. For advice specifically tailored to your unique situation, such advice should be sought independently from this educational content.