Business Trust Definition: Everything You Need to Know
A business trust definition is for a form of business organization that is comparable to a corporation. 3 min read
2. Business Trust versus Corporation
3. Examples of Business Trusts
Updated October 28, 2020:
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.
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.
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.
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