You don’t have to wear an ascot or pearls to benefit from a trust. Affluent individuals may use trusts to lower their estate tax bills, but all trusts offer control. The latter feature benefits everyone, letting you decide how, when and why to transfer assets. This matters to business owners, because their companies are typically their largest assets.
If you believe a trust can benefit you, your small business and your heirs, consider working with an estate planning attorney and an accountant experienced in trusts. They can help you understand these complicated instruments.
Here are some basics: A trust is a legal entity that holds assets for the benefit of a person or charity. These assets can include anything from cash and securities to insurance and even your business, if your business is organized as an S corporation. A trust document governs how, when and why the trust distributes these assets to beneficiaries.
It also pays to understand a few terms:
- Property. Any asset owned by the trust, including securities, property, collectibles and business interests.
- Grantor. The person who sets and transfers property to the trust.
- Beneficiary. Any person or charity who receives the trust’s property.
- Trustee. Person or financial institution who legally manages the trust.
- Applicable Exclusion Amount. The amount exempt from federal estate and gift taxes.
- Irrevocable Trust. A trust whose terms are permanent; you can’t change them. This type of trust owns assets until they pass to beneficiaries after the grantor’s death.
- Revocable Trust. A trust whose terms can be changed during the grantor’s lifetime. This type of trust holds assets until the terms of the trust dictate where assets go next.
How a Trust Might Work
Consider this hypothetical example. You are the grantor who creates an irrevocable trust. You are widowed or single, so your federal applicable exclusion amount is slightly over $5 million. You transfer ownership of $1 million in assets to this trust. When you die, your heirs have to pay federal estate taxes on anything over $5 million and change and you had $6 million in total assets. But you carved out $1 million of that and gave it to the trust, whose assets are estate tax free.
The result? Your estate stays under the applicable exclusion amount and your heirs don’t pay any federal estate tax.
Taking Care of Trust Specifics
As the grantor, you choose how and when to eventually transfer assets. If the trust is irrevocable, consider the terms you include before finalizing them. Remember, you can’t change an irrevocable trust. You may have the trust distribute all assets after you die, gradually distribute assets or keep the assets in the trust for a fixed period, paying an income to beneficiaries you name.
You may also want to have what’s called a pour-over will. This document, essentially states that any assets held outside the trust were meant for the trust. A pour-over will ensures these assets transfer to the trust after you’re gone.
Don’t forget to make sure your trust has a trustee removal clause, in case you strongly disagree with the trustee. You should also state in the trust document how the trust will manage its assets.
