Key Takeaways

  • A business trust is a legal entity for holding and managing assets or conducting business, distinct from a corporation or LLC.
  • Business trusts may be known as Massachusetts trusts or common law trusts and involve three primary parties: settlor, trustee, and beneficiary.
  • The structure offers flexibility, privacy, potential tax advantages, and, in some cases, limited liability for beneficiaries.
  • There are important differences between business trusts, corporations, and LLCs, including how they are taxed, governed, and their compliance requirements.
  • Choosing a business trust may be beneficial for estate planning, asset protection, or specific business goals, but there are limitations and legal complexities.
  • Readers can find experienced business attorneys on UpCounsel to assist with forming or managing a business trust.

A business trust definition is for a form of business organization that is comparable to a corporation. It is where investors are receiving transferable “certificates of beneficial interest.” A business trust doesn't obtain a state-issued charter although it receives business protections that resemble those of a corporation. 

What is a Business Trust?

A business trust may also be referred to as a Massachusetts trust or common law trust. A business trust's formation and structure are comparable to other similar structures. Trusts are real property, or assets, or both, which are overseen by someone appointed to manage the interest for the beneficiary. The trustee is an appointed individual and the person who owns the property in the trust is the settler. The role of the trustee is to administer the trust for the beneficiaries' advantage, and the beneficiaries are the ones that hold equitable title to the trust. 

A declaration of trust is what sets forth the terms of the administration. Trusts are a common aspect of estate planning for those who want to leave assets to their children but instead leave everything in the hands of a trustee. In the case of children under 18, or someone who is not trusted with handling money, the trustee ensures the beneficiaries interests are fully represented. 

Creating a trust occurs when the settler (or donor) signs a declaration of trust, which is what provides the instructions for the trustee. The declaration of trust must have several essential provisions: 

  • Detail the trust's terms
  • Declare how long it's valid
  • Identify what are the duties and powers of all trustees
  • Specify the interests of the beneficiaries

Once the assets transfer into the trust, the trustee has a fiduciary duty to all beneficiaries.

It's not uncommon to see trusts conduct a variety of business transactions like the purchase and sale of assets — including real estate — and stocks, commodities, and bonds. Business trust beneficiaries receive certificates of beneficial interest which serve as proof of their rights to any benefits under the trust. These certificates are legally transferable to another party, or can even be sold to someone else. Distributing any profits and losses from the trust to the beneficiaries follows the holdings of beneficial interests. When the trust's duration is ending, business owners will then transfer to the trust's beneficiaries. 

When looking at a trust for income tax purposes, this is where it's treated like a corporation. To set up a business trust, the business must prove that it's involved in an authentic business practice. It can include investing, buying and selling products, or the manufacture of goods.

How Does a Business Trust Work?

A business trust operates by transferring assets or operational control of a business to a trustee, who manages those assets for the benefit of designated beneficiaries. The trust is typically established by a written document called a trust agreement or declaration of trust. This document outlines the roles and responsibilities of the trustee, the rights of beneficiaries, and the management of the trust's property or business operations.

Business trusts are sometimes used to manage family businesses, real estate portfolios, or as investment vehicles. Unlike corporations, a business trust does not issue stock but instead provides "certificates of beneficial interest" to beneficiaries. These certificates represent ownership stakes and are often transferable. Business trusts may be registered in some states, but not all require formal registration, adding an element of privacy to their operation.

Key parties in a business trust:

  • Settlor (or grantor): The individual who creates the trust and transfers assets into it.
  • Trustee: The person or entity responsible for managing the trust in accordance with the trust agreement.
  • Beneficiaries: Individuals or entities who receive the benefits or profits from the trust.

The trustee’s duties are fiduciary, meaning they must always act in the best interests of the beneficiaries. The trust may be established for a specific period or for the duration of the business’s existence.

Advantages and Disadvantages of a Business Trust

Advantages of a Business Trust:

  • Asset Protection: Business trusts can shield assets from creditors or legal actions, depending on state law and proper structuring.
  • Privacy: Trusts do not always require public filing, offering more privacy than corporations or LLCs.
  • Estate Planning: Trusts can be used to pass business interests smoothly to heirs, avoiding probate.
  • Flexibility: Trustees can be granted wide powers to manage, buy, sell, or reinvest trust property without the need for shareholder votes.
  • Tax Benefits: Depending on structure, a business trust may be able to pass income and losses directly to beneficiaries, avoiding double taxation.

Disadvantages of a Business Trust:

  • Legal Complexity: Setting up and managing a business trust can require significant legal expertise.
  • Regulatory Variability: Laws governing business trusts differ significantly between states, leading to potential confusion.
  • Perceived Unfamiliarity: Some investors, lenders, or partners may be less comfortable with trusts compared to more familiar entities like LLCs or corporations.
  • Potential Liability: Depending on state law, beneficiaries might be exposed to liability if the trust is not properly structured.

Business Trust versus Corporation

The use of a business trust originated many years ago as a way to circumvent restrictions placed on real estate development and corporate acquisitions while keeping the desirable limited liability feature of a corporation. Business trusts differ from corporations because they derive their status from the voluntary actions of the people who form it. There is no state charter that gives it any sort of legal status.

In some states, business trusts must follow a law of trusts while other states look to the laws of corporations or partnerships to govern their existence. In states that treat trusts as partnerships, it would hold the beneficiaries liable for particular aspects of the business. In general, beneficiaries of a business trust have limited liability. If the particular state does treat a business trust as a partnership, the beneficiaries could be fully liable for any judgments made against the trust.

Business Trust versus LLC

Both business trusts and LLCs are popular ways to manage business assets, but they serve different purposes and offer distinct advantages and drawbacks.

Key Differences:

  • Formation and Regulation: LLCs are governed by specific statutes in each state, while business trusts are primarily governed by common law or specific state trust statutes.
  • Ownership: LLC owners are called members; business trust owners are beneficiaries who hold certificates of beneficial interest.
  • Management: LLCs can be member-managed or manager-managed; business trusts are always managed by trustees according to the trust agreement.
  • Taxation: LLCs offer flexible tax treatment (partnership, S corp, or C corp status), while business trusts can be taxed as partnerships or corporations, depending on their structure and IRS rules.
  • Liability Protection: Both structures can provide liability protection, but in some states, improperly structured business trusts may not shield beneficiaries.
  • Continuity: LLCs often have perpetual existence, while business trusts may be set up for a fixed term or until a certain event occurs.

When to Choose Each:

  • LLC: Best for businesses seeking simple, flexible management and clear liability protection.
  • Business Trust: Suited for holding assets, estate planning, privacy, or situations where flexible management by a trustee is desired.

Examples of Business Trusts

There are several different types of business trusts to familiarize yourself with:

  • Grantor trusts: These have three parties (grantor, trustee, beneficiary) and manage their own wealth and provide for their eventual heirs.
  • Simple trust: This type of trust is when the parent business does not oversee its own trust's management and the IRS has to verify whether it accurately meets the definition of a simple trust. A simple trust is a requirement in order to distribute their entire profits to the parent entity from the tax period where it recorded those profits.
  • Complex trust: The parent entity doesn't handle the managing of the trust and it does not meet the simple trust requirements, so it is a complex trust. They also differ from simple trusts as there are no strict guidelines on profit allocation.

Common Uses of Business Trusts

Business trusts are often chosen for:

  • Family Businesses: Ensuring smooth transfer of control and income to the next generation.
  • Real Estate Holdings: Facilitating the management and transfer of income-producing properties.
  • Investment Funds: Pooling investor money to purchase and manage assets.
  • Asset Protection: Shielding assets from creditors under certain circumstances.
  • Succession Planning: Simplifying the transfer of business interests upon the death or incapacity of the owner.

Each of these uses leverages the business trust’s ability to separate legal control (trustee) from economic benefit (beneficiaries).

Potential Risks and Limitations

While business trusts offer significant advantages, it’s important to be aware of possible risks:

  • Uncertain Legal Standing: Because laws vary widely by state, a trust may not always provide intended protections.
  • IRS Scrutiny: The IRS may classify a trust as a corporation for tax purposes if it resembles one too closely, changing its tax obligations.
  • Difficulty Raising Capital: Lenders or investors may hesitate to work with a business trust due to unfamiliarity or lack of transparency.
  • Complexity in Dissolution: Terminating or transferring a business trust can be more complicated than with other entities.

Due to these factors, consulting with an attorney experienced in business trusts is essential for proper setup and ongoing management.

Frequently Asked Questions

1. What is the main difference between a business trust and a corporation?

A business trust is managed by trustees for beneficiaries and is not created by filing articles of incorporation with the state. A corporation is a state-chartered entity with shareholders and a formal management structure.

2. Are business trusts recognized in all states?

No, recognition and regulation of business trusts vary widely by state. Some states have specific statutes, while others rely on common law principles.

3. Can a business trust provide liability protection?

In many cases, yes. Properly structured business trusts can shield beneficiaries from personal liability, but state law and trust structure are crucial factors.

4. How are business trusts taxed?

Tax treatment depends on the structure and activities of the trust. Some are taxed as partnerships, while others may be treated as corporations by the IRS.

5. When should I use a business trust over an LLC or corporation?

A business trust may be advantageous for estate planning, privacy, asset protection, or managing investment funds. LLCs and corporations are better for operating companies needing clear statutory liability protection and investor familiarity.

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