What Is a Business Trust and How Does It Work?

Definition

There are several different types of trusts. You’re probably familiar with individual trusts, family trusts or trust funds, which are designed to manage personal or family assets. However, another type of trust exists specifically for businesses—known as a business trust or common law trust. This legal structure allows trustees to manage a beneficiary’s stake in a business or even operate the business itself. Business trusts come in various forms, each functioning differently based on its purpose and structure. If you’re considering using a business trust, consulting a financial advisor can help you determine the best approach for your specific needs.

What Is a Business Trust? 

A business trust operates much like an individual or family trust, allowing a trustee to manage assets on behalf of the grantor. While individual trusts typically hold assets like money or real estate, a business trust holds ownership rights to a business interest. In some cases, the trust itself may serve as the legal entity that owns the business.

Business trusts can have one or multiple beneficiaries, and a business may be owned by a single trust or multiple trusts and entities. These structures are often used to protect assets from taxes and liability, as trusts generally offer different legal protections compared to individual ownership. However, the specific regulations governing business trusts vary by state.

How Does a Business Trust Work?

A business trust is a legal agreement. In turn, the process of creating one typically begins with a conversation between the involved parties and a trust lawyer who can help define the terms of the agreement. Following this, the trust is legally created through what is called a declaration of trust.

The declaration of trust details the terms of the trust and delegates instructions and responsibilities for the trustee. These may include the valid length of the trust and the duties, powers and interests of the beneficiaries. Once the terms are settled, the one who owns the trust signs the declaration, officially creating it in the process.

The trustee of a business trust has a fiduciary duty to act in the best interests of the beneficiaries of the trust. This is the same kind of fiduciary duty that applies to other financial situations. Most notably, SEC-registered financial advisors have a fiduciary duty to act in the best interests of their clients.

The trustee is the one who holds the rights and control of the business stake in the trust. It’s typically one individual serving as a trustee of a business trust. At the end of the trust’s length, the business interests transfer to its beneficiaries. Business trusts are treated as corporations and may conduct business transactions just like individuals.

Types of Business Trust

Just as there are several different types of individual trusts, there are three main categories of business trusts. Here’s a breakdown of each:

Grantor Trust

The first type is called a grantor trust. Grantor trusts consist of a grantor, a trustee and a beneficiary. This type of trust is very self-contained. The grantor pays taxes on th income that comes from the trust and has complete control over it. This includes control over business distributions to the beneficiaries. 

Simple Trust

Next is a simple trust. For a trust to fall into this category, its status must be verified by the IRS. With a simple trust, the trustee must distribute business profits directly to the beneficiaries. It’s also prohibited from doing things like touching any principal assets.

Complex Trust

A complex trust is in some ways the opposite of a simple trust, though it still isn’t managed by the beneficiaries of the trust. Business profits and other funds may be distributed only in part to beneficiaries and may even be contributed to other organizations, such as charities. In order to maintain status as a complex trust, the trust needs to have at least some form of income.

The Pros and Cons of Business Trusts

A business trust offers unique advantages, making it an appealing structure for certain business owners. For example:

• Liability Protection: Beneficiaries are shielded from personal liability, similar to an LLC or corporation.
• Privacy Benefits: Trusts offer an additional layer of confidentiality compared to traditional business structures.
• Flexible Distribution Terms: The trust can specify how and when beneficiaries receive distributions, making it an effective estate planning tool.

While business trusts have notable benefits, they also come with challenges that may make them less practical for some business owners, such as:

• High Costs and Complexity: Establishing and maintaining a business trust typically requires legal assistance, which can be expensive.
• Ongoing Legal Compliance: Business trusts may face regulatory hurdles that require continuous oversight.
• Limited Lifespan: Most business trusts cannot extend beyond 99 years, making them unsuitable for multi-generational business planning.

How to Set Up a Business Trust

If you’re interested in setting up a business trust, the first step is to talk to an attorney who can help. As we state above, you’ll likely need to work with an attorney throughout the life of your business trust. Note that trust lawyers typically charge around $500 per hour and the outright cost to set up a business trust could be more than $5,000. 

Once the trust is up and operating, the hardest part is officially out of the way. While you may need to amend the trust down the road, you’ll have to detail some of the most important terms, such as the distribution schedules, trustees and beneficiaries.

Bottom Line 

A business trust is often difficult to set up, and it’s not a necessary part of every business out there. Your business arrangement may be good as it is, or you may be better suited to use a limited liability corporation (LLC), a partnership or another type of structure. Before you pull the trigger on creating a business trust, it’s important to figure out the key elements surrounding it.