A Business Structure Called Trust
Let’s say, for example, you’re the owner of a small business and a widower with two little kids. When you know you’ll become incapacitated because of a worsening illness, you would want to leave the firm in good hands. Since you can’t leave the company to your kids and there’s no one else to manage it, the only option is to ask your brother to take care of it after you’re gone. In this case, you can create a business structure where the business is put under a trust that’s managed by your sibling for the benefit of your children’s future.
How a Trust Works
In this relationship, the trustee – your brother – is given the right to control the daily operations of your business and make decisions for the good of your kids, which are the trust’s beneficiaries. However, the company will be legally owned by your children once they reached 18 years old or when they’re old enough to manage it. However, this is just an example of the kind of situation that setting up a trust works better for your family and your business. Commonly, the trustee is also an entrepreneur or another company that can temporarily “adopt” your business until your beneficiaries are ready.
As a legal entity, the trust doesn’t function separately from the trustee. Thus, the company can enter into contracts, acquire debts, be sued or sue in return, become liable for the trustee’s actions, and assume obligations. The corporate trustee may be given the discretionary power to decide how best to divide the annual profits of your business to the beneficiaries. In some cases, the trust already prescribes a fixed amount to be distributed to all beneficiaries of the trust.
Advantages of Setting Up a Trust
Primarily, a trust is set up to protect the business owner’s assets and other properties. Despite its name, the trust exists because it assumes that a beneficiary who’s still a minor or someone who lack the skills and knowledge is not fit to manage the business. In a discretionary trust, the corporate trustee may distribute the company’s profits to all beneficiaries in such a way that it’s tax effective for the business. While the beneficiaries earn income from the trust, however, they don’t incur debts like sole proprietors and partners do. So, each beneficiary pays income tax based on his or her marginal rates.
Disadvantages of a Trust
A trust is part of an estate plan, which a lawyer with the help of an accountant draws up for a client. Certainly, it costs more to set up a trust compared to establishing a partnership or sole trade. It’s also more complex as a business structure compared to the other types. Similar to any company, a trust must follow the rules and regulations of operating a business.
In case the business incurs a loss, the beneficiaries can’t cover it up by offsetting their income with the negative balance. They’ll receive the full amount that’s due to them while the corporate trustee must find other ways of putting the bottom-line figures back into black. In addition, a trust will be taxed when it decides to retain profits for future expansion. Also, the trustee cannot refuse or neglect his or her obligations in managing the trust for the beneficiaries.