Trusts and limited liability companies (LLCs) are both legal vehicles that can be used to manage and protect assets, minimize taxation, and avoid probate.
Whether a trust or an LLC is a better choice may depend on the type of asset, but you do not necessarily have to choose between the two. In fact, an LLC can be placed in a trust. To explain how that works, it is first necessary to better understand each type of entity and clear up some common misconceptions about them.
What Is a Trust?
When most people think of a trust, they think of a vehicle for transferring intergenerational wealth. While this is not too far off the mark, trusts are not exclusively for the wealthy. They are, however, a common way to avoid probate (the legal process of settling an estate when somebody passes away) and plan for estate taxes.
For starters, it is not just money that can be placed in a trust. Trusts can hold cash, but they can also hold other assets such as bank accounts, securities, life insurance policies, real estate, intellectual property, personal possessions, cryptocurrencies and nonfungible tokens (NFTs), real estate, and ownership interests in a business—including an LLC.
This is not a complete list of what you can put in a trust. The ability to transfer title of an asset to a trust does not mean that it is the best place for it. Before placing any asset in a trust, consult an attorney about how the transfer might affect taxation, liability protection, and probate.
Once you have decided that certain assets belong in a trust, the next step is to create the trust. You will need to specify the assets to be placed in the trust, somebody to oversee the trust assets (a trustee), the individuals who will receive the trust assets at the specified time (the trust's beneficiaries), and instructions for distributing trust assets to beneficiaries (the trust agreement). In addition, you will need to fund the trust by transferring title of the assets into the name of the trustee.
You will also have to choose the type of trust. A revocable trust is more flexible and can be changed during your lifetime, whereas an irrevocable trust cannot be changed once created. A testamentary trust can be created at the time of your death per instructions in your will.
A key feature of trusts is that once your assets are transferred into the trust, they technically are no longer your personal property. They are the property of the trust, which is managed by a trustee for the benefit of the beneficiaries.
This explains why some trusts can help minimize or avoid estate taxes. Also, because assets in a trust are not part of your estate at death, they do not have to be transferred to your heirs through the probate process; they are instead distributed according to the trust terms.
What Is an LLC?
An LLC is a type of business entity that provides liability protection to its owners and avoids double taxation. In terms of liability protection, when an LLC takes on debts and liabilities, its owners' personal assets generally cannot be seized by creditors of the LLC as payment for what the business owes. LLCs also are not taxed at the corporate level. Instead, LLC owners pay taxes on business profits on their personal income tax return. This avoids the double taxation applicable to corporations.
LLCs, like other businesses, have assets such as real estate, vehicles, tools, equipment, and intellectual property. And like a trust, just about any type of asset can be transferred into an LLC, including personal assets like cash and bank accounts, property, and personal possessions. Thus, LLCs can also serve as tools in the estate planning process. To start an LLC, you file the articles of organization with the secretary of state where the business is located. That could be your home state, but you can start an LLC in any state. If you are primarily looking for asset protection, then it might pay to shop around in different states. Nevada and Wyoming have statutes providing strong asset protection. An attorney can help you identify the right state for your unique needs.
Most states also require you to file a report at least once per year. At startup, you pay a one-time filing fee. When filing an annual or biannual report, expect to pay approximately $100-$500 per filing.
The other major document for your LLC is the operating agreement. While it must comply with state LLC laws, the operating agreement typically does not have to be filed with the secretary of state. This document specifies the LLC's internal rules and procedures. Although it is not always advisable, you can stipulate in the operating agreement that, when you die, the business passes to your heirs, or the income from the business goes to your kids. It is important to check with your attorney to ensure that you have carefully thought through all of the ramifications, for example, whether the heirs are prepared to become business owners and if this plan is acceptable to any existing business partners. Similar to a trust, transferring the LLC interests to beneficiaries can be a way to avoid probate.
Not only can you manage and pass on a family business through an LLC, you can also place assets in the LLC such as rental properties and vacation homes. In fact, just about any asset can be placed in the LLC, including money and personal possessions. Those with large estates can use a family LLC structure to minimize gift and estate taxes.
Is a Trust or an LLC Right for You?
To summarize, trusts and LLCs both have value as legal instruments that can shield assets from taxation and avoid probate.
LLCs have the added benefit of personal liability protection, but they typically have higher ongoing costs than trusts. One benefit of those higher costs is that you have a greater ability to manage the assets in an LLC. As noted, once you place assets in certain types of trusts, they are out of your hands. But there is a trade-off with regard to privacy. Trusts never become part of the public record, while the existence of an LLC—though not necessarily the identity of its members (depending on your state's law)—is public information.
Some trusts and LLCs, when set up correctly, have the potential to protect assets from creditors. With trusts, you have to be careful to choose the right type of trust for maximum creditor protection. Even then, there is no guarantee that your beneficiaries will be completely protected. LLC asset protection varies by state, and care must be taken to treat the LLC's assets separately from your personal property to keep creditors from being able to “pierce the veil” of the LLC and come after your personal assets.
In short, there are trade-offs associated with using either a trust or an LLC. One common way to minimize these trade-offs is to place an LLC inside a trust. If a trust owns an LLC, it adds another layer of asset protection. In addition, one way to avoid having your name on state registration documents is to hire a third party to form the LLC for you and act as your registered agent.
Beyond the basic pros and cons of each legal vehicle, it comes down to how the trust or LLC is structured. Our legal team can help you choose the right tools for your needs and draft the agreements that align with your goals. To set up an appointment, please call or contact us.