If you’ve decided to incorporate your business or review the type of entity you already have in place, it’s essential to not only choose the right entity, but also decide who (or what) should own that entity. Unfortunately, most basic business lawyers overlook this question, and I want to ensure you don’t miss it just because they do.
The answer to who (or what) should own your business entity depends on the risks you face, such as incapacity, divorce, bankruptcy, and death. Given that death is a certainty, at the very least, your business interests should be owned in a revocable living trust. This is true regardless of whether your business is a limited liability company (LLC), corporation, or partnership.
A revocable living trust holds your business assets, so upon your incapacity or death, your successor trustee can step in, and without any need for court involvement, he or she can handle your business affairs. Because the trust is revocable, there is no separate tax ID, no tax consequences, and nothing to do other than have the trust agreement created and your business ownership re-assigned to the trust. And as long as you are working with a lawyer like us, who can ensure you make the right decisions and get it drafted properly, living trusts are easy to set up.
However, one downside of a living trust is that there’s no protection from creditors, divorce, or estate taxes. If you are building a business that likely won’t have a high future value, is merely a cash machine for you, and won’t earn you millions of dollars one day, then owning your business in a revocable living trust may be just fine.
But if you are building a business that will one day be worth millions, you should consider not owning the business in your name via a living trust. Instead, you may want to look into holding the business in an irrevocable trust.
With an irrevocable trust, the business is owned by the trust, not you. Since you can’t lose what you don’t own, creditors and lawsuits cannot reach your company and its assets if it’s inside such a trust. Furthermore, if you anticipate significantly growing the business’ value, an irrevocable trust can also provide estate tax protection.
An irrevocable trust has its own tax ID number, and the trust is a separate taxpayer from you. You can then establish the trustee of the trust as the owner of the business, and while you may be the investment trustee, there’s another trustee involved: an independent trustee, who is the trustee for purposes of distributions and who creates a layer of asset protection and also protection from estate taxes.
Here’s the bottom line: If you are building a business that will last only for your lifetime, you can (and should) own the whole business, or at least your share of the business, yourself—and ideally, inside a revocable living trust. On the other hand, if you are building a business that may be worth millions in the future or you want to be able to leave the business and those millions for your loved ones, it’s a good idea to consider owning the business inside an irrevocable trust, rather than in your name.
And why would you not want to own your business in your name? Owning your business in your name comes with several risks, namely liability and taxes.
If you own your business in your own name and you get into personal trouble of any sort, or even if you get divorced, your business could be taken to satisfy a judgment against you. For example, when New Law Business Model founder and CEO Ali Katz went through a divorce in the early 2000s, she had to buy half of her law firm from her husband as part of the divorce settlement. That’s a pretty common example.
But here’s a less common example. Ali’s friend, Anthony, was staying in a friend’s penthouse apartment in New York City. While his friend was out of town, Anthony decided to run a bath. When another friend called and invited him to go out, Anthony left and forgot to turn off the running bath.
When he arrived back at the apartment at 2 a.m., the doorman informed Anthony that the bath had flooded the entire apartment and the one below. The damage came to a total of $400,000, and while the insurance on the apartment covered the claim, the insurance company wanted Anthony to reimburse them under what’s called “subrogation.”
If Anthony had owned assets of any value, including a business, the insurance company would have sued him. The suit would have likely resulted in a judgment for $400,000, and a court could have taken any business in Anthony’s name to satisfy the judgment.
Protecting your business from such liability is one reason you may not want to own your business in your name—and that’s true for a business of any value. But as mentioned earlier, if you are building a big company that will be worth a lot of money one day, you may want to consider owning it inside an irrevocable trust, rather than in your name.
Another reason to own your business in an irrevocable trust instead of your name is that upon death, you will likely want your business to be outside your estate for estate tax purposes. In 2023, the estate tax exemption is $12.92 million per individual, meaning you can die with $12.92 million of assets and not pay any estate taxes. However, all estates over $12.92 million pay an estate tax of 40%. This requirement means that if you have a high-value business, it will surpass this threshold, forcing your loved ones to pay a huge tax bill to inherit your business.
Furthermore, the estate tax rate can fluctuate depending on what administration is in office and the federal government’s needs. And depending on where you live, your state may have a much lower estate tax exemption. Massachusetts, for example, taxes estates worth more than $1 million. In either case, unless you plan to protect your business, your loved ones would face needless expenses following your death.
By setting up your business inside an irrevocable trust, your business’ value grows outside your estate for estate tax purposes. To avoid having your loved ones pay exorbitant taxes upon your death, consider owning your business inside an irrevocable trust. And as we pointed out earlier, an irrevocable trust also provides liability protection from creditors, lawsuits, divorce, and bankruptcy.
If you already own your business in your name, it may not be too late to move the business into an irrevocable trust structure. But you’ll definitely want to consult with a trusted family business lawyer like us, who understands these structures, so you can get things set up properly. And you’ll want to do this as soon as possible, since incapacity and death can strike at any time.
If you have not yet started your business, but you are confident the business will be worth millions one day, contact a Personal Family Lawyer® with business planning expertise before you incorporate. We can set up an irrevocable trust to provide your business with the most airtight asset- and estate-tax protection you can get through legal planning. And if you simply need to set up a revocable living trust for your business, we can help with that, too. Contact us today to get started.