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Sole Proprietorship
A sole proprietorship
offers absolutely no
asset protection.
The sole proprietorship is probably the most common and least complicated business structure utilized in America today. While it does have a few advantages, they
are far outweighed by the disadvantages in terms of asset protection. A sole proprietorship is simply one person engaging in a business that he or she owns and manages. The person is responsible for all business transactions as well as all debts and
liabilities incurred by the business. The business can be sold or even passed down
to the sole proprietors’ heirs. It requires no formal formation like a Corporation or a
Limited Liability Company (LLC).
Advantages
›› Complete control and decision making power
›› Sale or transfer of the business at the sole proprietors’ discretion
›› No corporate tax payments
›› Ease of formation
›› Relatively few formal business requirements
Disadvantages
›› The sole proprietor can be held personally liable for the debts and obliga-
tions of the business
›› Risk of liability resulting from acts committed by employees of the company
›› All business decisions and responsibilities fall to the sole proprietor
›› Difficulty in securing investors; sole proprietors must rely on loans or per-
sonal assets
A sole proprietorship offers absolutely no asset protection. Since a sole proprietorship is not a separate legal entity, any liability will likely belong to the proprietor
alone. This is a frightening possibility because the potential litigant or creditor may be
able to strip the proprietor of their assets; including non-business assets.
Because the sole proprietorship offers no asset protection we will spend very little
time discussing it.
Tax Planning
The sole proprietorship is the simplest legal structure for business ownership. It
is a one person business that is not registered as a corporation or Limited Liability
Company. However, even though a sole proprietorship is the simplest of business
structures, it does have drawbacks. As previously discussed, a sole proprietor can
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be held personally liable for any business-related obligation.
A sole proprietorship is not a separate business entity for tax purposes, and therefore it may not be sold as such. The sale, or transfer, of each individual asset of the
business will be considered a separate transaction, and any gain or loss on such sale
must be determined and reported on an asset-by-asset basis.
The sole
proprietorship
is by far the least
burdensome business
structure from
an administrative
standpoint.
Advantages:
›› The owner and the business are the same entity for tax purposes. This
requires a single tax return reporting the businesses income as a part of
the owner’s tax return.
›› The owner of a sole proprietorship can be an individual, partnership, cor-
poration, Limited Liability Company or trust.
›› Losses from a sole proprietorship may be used to offset income from
other sources on the owner’s tax return.
Disadvantages:
›› Sole proprietorships tend to be audited by the IRS more frequently than
any other type of business entity.
›› Sole proprietorships offer very limited tax planning opportunities for in-
come deferral or employee benefits.
›› Income from sole proprietorships is subject to self-employment tax.
Administration
The administrative ease of a sole proprietorship is what
makes it such a dangerous trap. The sole proprietorship is by
far the least burdensome business structure from an administrative standpoint. A sole proprietorship’s administrative requirements are almost non-existent.
There is no filing requirement, for formation purposes, with
a sole proprietorship because it is not a separate legal entity.
Also, because a sole proprietorship is not a separate legal entity, no separate business bank account is required, although it
is advisable. The sole proprietorship has no filing requirement
with the IRS; all the income and expenses are reported on
Schedule C of the personal income tax return.
From an administrative standpoint the sole proprietorship is the preferred entity. However, for tax and asset protection reasons the sole proprietorship is
not advisable.
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Partnership
If the limited liability
partnership were to
be sued, all of the
general partners’ assets
would be at risk. The
limited partners, on
the other hand, only
have liability up to
the amount of their
investment in the
limited partnership.
In this section we will discuss two types
of partnerships — general partnerships and
limited partnerships.
The simplest way to describe a general
partnership is a business enterprise entered
into for profit, which is owned by more than
one person. A general partner may or may not choose to invest in the partnership;
however, he or she will participate in running the partnership and is liable for all acts
and debts of the partnership or any of its partners. Each partner shares in the profits
and shares in the liability of the partnership, including losses. As with the sole proprietorship, the general partnership is not a separate legal entity and, therefore, any
potential liability would be focused on the partners. The general partnership, like the
sole proprietorship, offers no asset protection.
We disfavor general partnerships for the same reason we disfavor sole proprietorships — no asset protection! There will be further discussion of general partnerships
in the taxation and administrative sections.
A limited partnership allows for two classes of partners — limited partners and
general partners. Limited partnerships are controlled by the general partners who
run the day to day operations of the limited partnership and are charged with conducting most of the partnership’s business. Limited partners on the other hand are
simply investors and are not involved in the management of the limited partnership.
The choice in this type of business agreement is to have control over an investment
(general partner) and be subject to unlimited liability or to have limited liability, but
no control. In fact, if the limited partner were to exercise some type of control, or
be involved in the management of the limited partnership, his or her limited liability
status could be compromised. The argument is that once a limited partner begins
acting like a general partner he, potentially, can be treated as a general partner and
be subjected to unlimited liability.
As stated above, the general partners of a limited partnership have unlimited liability. If the limited liability partnership were to be sued, all of the general partners’
assets would be at risk. The limited partners, on the other hand, only have liability up
to the amount of their investment in the limited partnership.
Tax Planning
A partnership is an association of two or more persons who organize as co-owners to carry on a business for profit. Partnerships come in two types for tax purposes, general partnerships and limited partnerships. General partnerships provide
no personal protection to the partners from legal liability. Limited partnerships provide
personal protection to the limited partners, but not to general partners. Hence, partnerships have a certain degree of risk which may outweigh any tax considerations.
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Advantages:
›› Partnerships are not subject to tax as separate entities. The partners are
subject to tax on their respective shares of partnership income or loss.
›› Partnerships offer opportunities for a single person or entity to exercise
control, without majority ownership by acting as the general partner.
›› Partnerships offer opportunities to shift income between taxpayers
through use of disproportionate contributions, special allocations, and distribution rights. This can be used to shift income from taxpayers in higher
marginal tax brackets to taxpayers in lower marginal tax brackets.
Partnerships offer
opportunities to
shift income between
taxpayers through use
of disproportionate
contributions, special
allocations, and
distribution rights.
›› Property may be contributed to a partnership or distributed from a part-
nership without triggering a taxable event. This may be of critical importance in the case of assets that have appreciated in value or for assets
that were acquired subject to debt.
›› Partners may be able to deduct losses from the partnership with respect
to their respective shares of partnership indebtedness. This is especially
relevant in real estate investment activities.
Disadvantages:
›› Because assets may be contributed to or distributed from a partnership
without being a taxable event, special rules exist for tracking the differences between the adjusted basis in the assets and the fair market values
of those assets.
›› Partnership income is subject to self-employment taxes if the partner
materially participates in the operation of the partnership.
›› Partnership income may be subject to passive activity rules for partners
who do not materially participate in the operation of the partnership. As
such, losses from a partnership interest may not be deductible in the year
they are incurred.
›› Partnership interests are generally very difficult to sell or exchange due to
the need to modify the partnership agreement to take into account the
newly admitted partner(s) and specifically describe the new economic
relationships.
Administration
Partnership’s administrative burdens will vary depending on the partnership. When
two people decide they are going to start a business together and form a partnership, a partnership agreement is usually drafted, although not necessarily required.
The partnership agreement will state how the partnership is to be operated and
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because partnership agreements are unique to each partnership, they can be very
simple or very complex.
It is difficult to say exactly what the administrative burdens of a partnership will
be without having read the partnership agreement. Most states do not even require
partnerships to register because they are not separate legal entities.
All partnerships, however, are required to file a Partnership Tax Return (Form 1065)
with the IRS on an annual basis. The partnership will also have to prepare Form K-1
for each of the partners. Form K-1 shows each partners’ allocation of income and
deductions from the partnership. The partner’s allocation of income and deductions
from the partnership will be reported on the partner’s individual income tax return.
Corporations
Corporations offer limited liability and consist of shareholders (owners), officers,
and a board of directors. They are given many of the same legal rights as an individual. The shareholders of a corporation can also be officers and/or members of
the board of directors. Conversely, shareholders do not have to be officers and/or
members of the board of directors of the corporations they own — third-parties can
be appointed. Shareholders vote and appoint a board of directors, who in turn appoint the officers. The board of directors is charged with making decisions that relate
to the company’s business purpose and appoint the officers who run the day-to-day
operations of the corporation.
A corporation is a separate legal entity created under the laws of the state in which
the corporation is formed. Shareholders have limited liability in the sense that their
liability is limited to their investment in the corporation making this type of entity a
major draw for smaller businesses. Officers and members of the board of directors
also have limited liability in the sense that they are not liable for the obligations of the
corporation; except in the case of special circumstances, like gross negligence.
Some states, like Nevada, also have what is
called a “Close Corporation.” Close corporations
have certain restrictions, such as, a limit on the
number of shareholders. The advantage of a
close corporation is that, at least in Nevada, it
can chose to operate with or without a board of
directors. This has advantages that are discussed
later in the administrative section.
S Corporations and C Corporations are also
options. From a state law perspective these entities are the same. The designation of “S Corporation” or “C Corporation” is simply a tax election
that will be discussed in the taxation section.
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C Corporation
The standard corporation, or C corporation, is the most common corporate structure. To create a C corporation, the proper formation documents, typically called the
Articles of Incorporation or Certificate of Incorporation, must be filed with the appropriate state agency and the necessary state filings fees paid.
Advantages:
›› One of the biggest advantages is that corporations are generally taxed at
a lower rate than their shareholders. This holds true when the shareholders are in a relatively high tax bracket and the corporation’s income is
relatively low, subjecting it to lower rates of taxation.
For 2014, Corporations are taxed at the following rates:
Corporations can
create opportunities
for shareholders to
defer tax. This arises
when shareholders do
not draw a salary and
the corporation does
not pay dividends.
Over—
But not over— Tax is:
Of the amount over—
$0 $50,000 15% -0-
$50,000 $75,000 $ 7,500 + 25% $50,000
$75,000 $100,000 $13,750 + 34% $75,000
$100,000 $335,000 $22,250 + 39% $100,000
$335,000 $10,000,000 $113,900 + 34% $335,000
$10,000,000 $15,000,000 $3,400,000 +35% $10,000,000
$15,000,000
$18,333,333 $5,150,000 +38% $15,000,000
$18,333,333 —
35% -0-
›› Corporations can create opportunities for shareholders to defer tax. This
arises when shareholders do not draw a salary and the corporation does
not pay dividends. In this case, the corporation pays tax, generally at a
lower rate than its shareholders, on its income and retains the profits as
retained earnings. This will allow the corporation to retain earnings until
the shareholder is ready to receive the income via a dividend. This can
be advantageous if the shareholder is currently in a high tax bracket but
expects to be in a lower tax bracket in the future.
›› If the shareholder wishes to receive some of the income from the corpora-
tion now and some at a later date, the corporation can pay the shareholder a salary. In this case, the corporation can elect to pay the shareholder
a reasonable salary and retain the rest of the profits until a later date, at
which time a distribution is made by paying a dividend. The corporation
can deduct, as an expense, the salary paid to the shareholder. However,
the corporation will still have to pay tax on the remainder of its income.
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›› Corporations provide an opportunity to purchase benefits for employees
that provide a tax benefit to the corporation, but may be tax-exempt to
the employees.
›› Corporations may be capitalized with both debt and equity. Interest
Corporations can be
subject to a surtax
of 39.6% if they are
determined to be a
Personal Holding
Company. The
Personal Holding
Company surtax can
be avoided if over 50%
of the corporations
income is derived from
rents.
payments on debt are deductible to the corporation, and payments to
the shareholders may avoid the double taxation of dividend distributions. However, care must be taken to insure that the debt-to-equity ratio
remains acceptable to the IRS. Additionally, many business expenses may
be tax-deductible; a C corporation can offer self-employment tax savings,
since owners who work for the business are classified as employees.
Disadvantages:
›› There is an issue of potential double taxation with corporations. Double
taxation arises when a corporation distributes dividends to its shareholders. First, the corporation must pay tax on its income at its income tax
rate. Second, the shareholder must pay tax on the dividend received,
creating double taxation.
›› As discussed above, a corporation can pay its shareholders a reasonable
salary. The corporation can deduct the salary paid from its income. However, if the IRS feels that the salary is unreasonable it can reclassify the
salary as a dividend. This, once again, creates double taxation because
the dividend is not deductible from the corporation’s taxable income. In
the past, shareholders have had the corporation pay all of its income to
them as salaries in an attempt to avoid double taxation. This often causes
the IRS to reclassify the salary as a dividend.
›› A corporation is not a pass-through entity and thus cannot pass its loss
through to its shareholders. This can be a big disadvantage in the ownership of rental property because rental property often incurs a tax loss due
to depreciation deductions.
›› Corporations can be subject to a surtax of 39.6% if they are determined to
be a Personal Holding Company. The Personal Holding Company surtax can
be avoided if over 50% of the corporations income is derived from rents.
›› There is also the risk that a corporation will be subject to an Accumulated
Earnings Tax in the amount of 39.6%. The Accumulated Earnings Tax is
triggered when, instead of distributing profits, the corporation retains them
in an effort to avoid paying income tax. There is, however, a safe-harbor
provision in the Internal Revenue Code that allows for accumulated earnings of less than $250,000 to be exempted from this tax.
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S Corporation
S corporations are corporations that have elected a special tax status with the
IRS. S corporations provide the same limited liability to owners, or shareholders, as
C corporations. This means that owners typically are not personally responsible for
business debt and liabilities; however, S corporations have pass-through taxation. S
corporations do not pay tax at the business level. They file an informational tax return
and business income/loss is reported on the owners’ personal tax returns and any
tax due is paid at the individual level.
Advantages:
›› An S corporation is generally not a taxable entity. All income, deductions,
S corporations
may be used to
dramatically reduce
self-employment taxes
on portions of their
income.
and losses pass through to its shareholders and the shareholders pay
income tax at their respective tax rates. This essentially eliminates double
taxation as it relates to corporations.
›› S corporations may be used to dramatically reduce self-employment taxes
on portions of their income.
›› If an S corporation has losses, it does not carry them over; instead, the
losses are passed through to the shareholders. The shareholders then deduct the loss, but only to the extent of their Adjusted Basis in the company. If the loss exceeds the shareholders’ Adjusted Basis in the company,
then the shareholders can carry the loss forward indefinitely.
Disadvantages:
›› The shareholders’ Adjusted Basis in the S corporation does not include
debt. In other words the shareholders’ Adjusted Basis is not increased by
the debts of the S corporation. This can be a big disadvantage in using an
S corporation to own mortgaged property. For the shareholder to include
debt in his Adjusted Basis the shareholder would have to borrow the
money and then lend the borrowed money to the corporation to purchase
the property. It has been argued that if the shareholder provides a guarantee for the loan, then the debt would be included in his Adjusted Basis.
However, this argument has been rejected by the courts. The shareholder
must have an actual financial outlay to include the debt in his Adjusted
Basis.
›› There are restrictions on corporations eligible to make an S corporation
election, the corporation must: (1) be a domestic corporation; (2) not be
an “ineligible corporation”; (3) not have more than 100 shareholders; (4)
not have a non-permitted shareholder; (5) not have any nonresident alien
shareholders; and (6) not have more than one class of stock.
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›› The S corporation election does not take effect until the subsequent year
after the election is made, unless the election is made in the first 2 ½
months of the tax year. This can be a disadvantage because of double
taxation, built-in gains (not discussed herein), and excessive passive
income (not discussed herein).
›› S corporations do not allow for Special Allocations of income. Therefore,
an S corporation must distribute its income, deductions, and losses in pro
rata shares to its shareholders.
Administration
Corporations are
also required, in
most cases, to have
an annual meeting
of the board of
directors and to
prepare minutes of
those meetings.
Corporations are probably the most administratively burdensome entities because
they are separate legal entities. Corporations must be formed under the laws of a
state and the state filing requirements must be met. In most states, such as Nevada,
corporations must file Articles of Incorporation, as well as an Initial List of Officers,
with the Secretary of State. On an annual basis the corporation will also have to file
an Annual List of Officers with the state Secretary of State.
Corporations are required to obtain an Employer Identification Number from the
IRS. Employer Identification Numbers are much like Social Security Numbers, but
for entities rather than for individuals. Corporations are required to file a Corporate
Income Tax Return (Form 1120) on an annual basis. In the case of a C Corporation
the corporation will have to pay its corporate income tax when it files its Form 1120.
In the case of an S corporation, a Corporate Income Tax Return must also be
filed (Form 1120S). The major difference is that an S corporation is not a taxable
entity and therefore does not pay any corporate tax upon the filing of its income tax
return. Instead the S corporation will issue its shareholders a Form K-1 allocating to
the shareholders’ portion of income and deductions and the shareholders will report
those amounts on their individual income tax return.
Corporations are also required, in most cases, to have an annual meeting of the
board of directors and to prepare minutes of those meetings. Corporations are also
required to pass resolutions of the board of directors for any transaction that is outside the normal day-today operations of the corporation.
Limited Liability Company
The Limited Liability Company (LLC) is probably the newest form of entity offering
limited liability. Wyoming was the first state to enact a Limited Liability Companies Act
and now every state has some version of a Limited Liability Companies Act.
Limited Liability Companies offer virtually the same limited liability protections as
corporations. As with the corporation and the limited partner of a limited partnership,
the only asset at risk is the members’ investment in the Limited Liability Company.
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Entity Information Guide
A member-managed
Limited Liability
Company is a
Limited Liability
Company that is
managed by its
owners; this is the
Page 10/14
State law governs the creation of Limited Liability Companies and they are separate
entities from their owners. The owners of Limited Liability Companies are referred to
as members. When organizing a Limited Liability Company the owner can chose a
member-managed or manager-managed.
A member-managed Limited Liability Company is a Limited Liability Company that
is managed by its owners; this is the most common type of Limited Liability Company. Manager-managed limited liability companies can be managed by one or more
of the members or by a third-party.
The members and managers of a Limited Liability Company are not liable for the
obligations of the Limited Liability Company. Managers of a manager-managed Limited Liability Company are much like the officers of a corporation. The members elect
the managers and managers conduct the day-to-day operations of the Limited Liability Company. One could structure a Limited Liability Company to operate much
like a limited partnership, but without the general partner (manager) having unlimited
liability.
Limited Liability Companies have many more advantages and they will be discussed in detail in the taxation and administrative sections.
most common type
Tax Planning
of Limited Liability
The Limited Liability Company is a relatively recent creation. The members of a
Limited Liability Company may elect how they want the Limited Liability Company to
be treated for tax purposes. The choices are to be taxed as a corporation, partnership or disregarded entity. Disregarded entity status is simply a tax election that can
be made with the IRS. By electing to be a disregarded entity you are able to eliminate
the filing requirement for a single-member LLC while continuing to enjoy the limited
liability status. The LLC is required to obtain an Employer Identification Number from
the IRS.
Company. Managermanaged limited
liability companies
can be managed by
one or more of the
members or by a
third-party.
Advantages:
›› A Limited Liability Company, taxed as a partnership, is not subject to any
entity level tax; instead it passes all of its income, deductions and losses
through to its members. This is very advantageous with regards to rental
property. Rental property often incurs losses due to depreciation deductions.
›› Special allocations are allowed. This means that a Limited Liability Com-
pany does not have to distribute its income, deductions and losses to its
members in a pro rata share as with the S corporation. The distribution of
income, deductions, and losses can be decided by agreement.
›› Members can deduct Limited Liability Company losses to the extent of
their Adjusted Basis in the Limited Liability Company, including their pro
rata share of debt.
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›› Unlike S corporations, members of a Limited Liability Company can
include in their Adjusted Basis, debt, except non-recourse debt, of the
Limited Liability Company for which they are personally liable. This greatly
increases the amount of losses a member can claim. This is very advantageous in regards to rental property because often rental property is
subject to a mortgage.
›› A Limited Liability Company is allowed to have nonresident alien members.
›› Losses from a Limited Liability Company can help offset the members’
ordinary income. This is especially important when a high income taxpayer
is a member of a Limited Liability Company that generates losses. This,
again, is very advantageous in the context of rental property because a
high income member can use losses, often due to depreciation deductions, to offset his ordinary income.
›› A Limited Liability Company is not subject to all of the corporate formali-
ties like a C corporation or S corporation. This is often viewed as an
advantage because of the simplicity of operation.
Disadvantages:
›› Members of a Limited Liability Company are liable for taxes on their share
of income at the end of the tax year regardless of whether or not the
Limited Liability Company made a distribution. The problem arises when a
Limited Liability Company retains earnings and does not distribute them to
the members at the end of the year. The members still have to pay taxes
on their share of the income. However, since they did not actually receive
any money they might not have the resources available to pay the tax on
their share of the income.
Administration
The LLC will have to file Articles of Organization with the Secretary of State for the
state in which it is to be created. Some states require an operating agreement for the
LLC as part of the registration, but others, such as Nevada, do not require an operating agreement for the LLC. The filing of Articles of Organization generally includes
filing a list of the members, and/or managers of the LLC. Most states then require an
annual filing that identifies any changes in ownership or management of the LLC. The
absence of a requirement to have an operating agreement makes it relatively easy to
form a LLC.
However, we must caution that an operating agreement that specifies all of the
rights, duties, and obligations of the members is essential when the LLC has more than
one member. In addition to registering in the state of organization, the LLC will have to
register as a foreign entity in all other states it conducts its business activities.
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The tax compliance requirements for the LLC depend on how the LLC will be
treated for tax purposes. If the LLC has a single member, it will be treated as a
disregarded entity and subject to the same reporting requirements as a sole proprietorship. The income or loss from the business will be reported as an attachment to
the owner’s federal and state tax returns on Schedule C if it is a trade or business,
Schedule E if a rental activity or Schedule F if a farming activity. It will be necessary
for the owner of the LLC to determine how much tax to deposit on a quarterly basis
with respect to income from the LLC.
The default tax reporting circumstance for a multi-member LLC is to be treated
as a partnership. The LLC will have to file a Form 1065, and the state equivalents,
to report the income or loss from the LLC as well as the Schedules K-1 reporting
each member’s respective share of the income and loss items. The members will
be responsible for determining the impact of the income or loss from the LLC, and
they will have to make estimated tax payments accordingly. If the LLC conducts and
active trade or business, and the member actively participates in that trade or business, then the member will also be subject to self-employment taxes for the income
derived from the LLC.
The other alternative is that the LLC elects to be taxed as a corporation. In such case the LLC may make an election to be taxed as
an S corporation, or it may pay taxes as a C corporation. The LLC
will have to file either a Form 1120 if it is a C corporation or a
Form 1120S if it elects S corporation status, plus the appropriate state income tax returns.
If the LLC is taxed as a C corporation the LLC will have
to determine its tax liability on a quarterly basis, and the
LLC will be required to make the necessary tax deposits. When the LLC makes distributions to its members
those distributions will be considered dividend distributions.
If the LLC has an S corporation election in effect, the LLC will not be subject to tax at the
entity level. It will report the aggregate income
from the business to the appropriate tax authorities together with the proportional division of
the income among the members. The members will be
responsible for reporting their proportional shares of the
LLC income on their respective individual income tax returns. Members of LLCs may be subject to estimated tax
deposit requirements if they own more than a 2% interest in the LLC that is taxed as an S corporation.
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Trusts
It is the duty of the
trustee to administer
the trust as outlined
in the declaration of
trust for the benefit of
the beneficiaries.
Trusts are interesting because they are
the only entities that do not have owners.
A trust is what is referred to as a “Jural Person.” The best way to describe a “Jural Person” is a “person” that was created by law.
Trusts consist of settlors, trustees, beneficiaries, and corpus (asset).
The settlor is the one who creates the
trust by placing an asset in the trust, and the
trustees administer the trust for the benefit of the beneficiaries. The settlor creates a
trust by executing a declaration of trust. The declaration of trust states who will be
the trustees and who will be the beneficiaries. Furthermore, the declaration of trust
lays out how the assets are to be administered and distributed by the trustee for the
benefit of the beneficiaries. Once the settlor has relinquished ownership to an asset
placed in trust, that asset becomes the corpus of the trust.
It is the duty of the trustee to administer the trust as outlined in the declaration of
trust for the benefit of the beneficiaries. Generally, the beneficiary has no right to the
asset in the trust until it is distributed to him by the trustee.
One simple way to view a trust is that the title to the asset placed in trust is “split”
into legal title and equitable title. The trustee holds legal title in that the trustee is
charged with the administration of the asset. The equitable title rests with the beneficiary because he is to receive the benefit of the asset.
Trusts can be very complex and require a competent professional for proper drafting. Since there is no “standard” trust there is much flexibility when creating a trust.
Trusts are especially useful for owning limited partnership interests, Limited Liability Company memberships, and corporate shares. The advantage is that these
securities can be placed in trust for the benefit of the owner’s children or other desired beneficiaries. The trust will be protected from potential litigation involving assets
owned by the limited partnership, Limited Liability Company or corporation because
those entities have limited liability. The greatest advantage is that interests can be
protected in those entities from any personal liabilities.
This discussion is a simplified explanation of the benefits of a trust. As stated
above this is a complex topic that is beyond the scope of this section.
Tax Planning
Trusts may be created in many forms, ranging from very simple to extremely complex. The goals of the person creating the trust generally have to take into consideration both income and estate taxation issues. Achieving the right balance of income
and estate tax benefits from a trust may require very sophisticated planning just for
the creation of the trust instrument.
Copyright 2015 Esquire Group, LLC
L a s Veg a s | P h o e n i x | V i e n n a | Frankfurt | UA E
[email protected] www.esquiregroup.com
Entity Information Guide
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Advantages:
›› Trusts can allow for transfer of beneficial ownership of a business or other
asset to others without the relinquishment of control of the business. This
can result in the transfer of income from taxpayers with high marginal tax
rates to taxpayers with lower marginal tax rates.
Disadvantages:
›› Trusts have very specific accounting and reporting requirements for tax
purposes. Those requirements restrict certain tax benefits from being
available to the beneficial owners of the trust that would be available if the
business was formed as a different entity type.
›› Transfers of property to trusts have to take Estate and Gift taxes into
consideration. Funding the trust may create a Gift Tax liability. This requires
consultation with an estate planner to determine the potential costs and
benefits of such an arrangement.
Administration
Creating a Trust is usually as simple as having a Trust Instrument drafted and
executed by the grantor of the Trust and the Trust being funded with the transfer of property to the Trust. Once this has been accomplished all administrative
and compliance requirements become the responsibility of the Trustee. The
Trustee will be responsible for accounting for the Trust income, determining the
income that must be distributed to the income beneficiaries, making the necessary
distributions to the income beneficiaries, filing the Form 1041 for the Trust to report
the taxable income earned by the Trust, and filing the Schedule K-1s for the income
beneficiaries reporting the amounts of income distributed to them by the Trust. The
income beneficiaries will then be required to report the amounts of income they received on their respective income tax returns.
The taxation of Trusts can become very complicated if the Trust does not distribute
all of its earnings in the year derived. The Trust will be subject to tax on undistributed
income at individual income tax rates. Additionally, Trusts generally retain capital gain
income for the benefit of the residuary beneficiaries. As such, the Trust itself may have
a tax liability that the Trustee must determine, and as necessary make the appropriate
tax deposits. Acting as Trustee for a Trust owning a business requires strict adherence
to a variety of laws, and we do not recommend it. If using a Trust to own a business
makes sense, the use of a professional trust administrator is a must. Such services can
be arranged through most banks, or with other private trust companies.
While Esquire Group, LLC uses reasonable efforts to include accurate and up-to-date information, we make no warranties
or representations as to the accuracy of the Content and assume no liability or responsibility for any error or omission in the
Content. Nothing herein shall be construed as tax or legal advice. The information contained herein is not a substitute for tax
and legal advice and is provided for informational purposes only.
Copyright 2015 Esquire Group, LLC
L a s Veg a s | P h o e n i x | V i e n n a | Frankfurt | UA E
[email protected] www.esquiregroup.com