If you own a rental property, you can transfer it to a limited liability company (LLC). You may already have an LLC or need to start one, but either ...
LLC vs. Trust
Updated on May 29, 2023
LLC vs. Trust
When starting a business, you might decide which business entity to form. One of the more popular options is a limited liability company, or LLC, due to its many benefits. Another solid option is a trust, which offers robust legal protections.
But these two business types serve distinctly different purposes and deliver different benefits. So how do you know which is right for you and your business?
This guide breaks down these legal structures to help you make an informed decision.
Trusts: What Are They?
First, trusts are not business entities but rather a means of holding and protecting assets to transfer them to beneficiaries. For instance, a parent might create a trust for their children to ensure their inheritance is protected and handed down correctly.
A trust can also be revocable or irrevocable:
- A revocable trust is adaptable; it can be altered or dissolved at any time
- An irrevocable trust requires a court order to be modified or dissolved
No form or application must be submitted to the state to create a trust. Instead, a trust is established via an official document, usually drafted by a lawyer, that names the trustee and beneficiaries.
The relevant assets are then legally placed into the trust, and the trustee is given guidelines for managing them. These assets may be:
- Real estate
- Life insurance plans and policies
- Business ownership
- Any other real property
What Are the Advantages and Disadvantages of a Trust?
The key benefit of a trust is that it’s legally distinct from the trust owner’s estate. For instance, a complex legal probate process will begin if an estate owner passes away without a trust in place.
But asset allocation is a much simpler affair. The trustee simply distributes assets to the heirs as laid out in the trust document. The beneficiaries receive the assets without having to pay estate taxes and without having to endure the probate process.
Unlike LLCs, trusts do not provide asset protection in the case of lawsuits. Moreover, they don’t offer the same income tax benefits as LLCs.
LLCs: What Are They?
Unlike trusts, LLCs are business entities. In most states, LLCs are formed by filing articles of organization, though some states refer to this document as a certificate of organization or certificate of formation.
Generally, you can fill this form out online, usually on the Secretary of State’s website. However, you’ll pay a fee upon submitting the completed document. Fees vary from state to state and range from $40 to $500, but they are often around $100.
The articles of organization form require you to provide your business name, address and registered agent information. In addition, some states also require the provision of member names and management structure details.
The majority of states require LLCs to appoint a registered agent. A registered agent is authorized to accept official correspondence on behalf of your business, such as legal, tax, or financial documents.
Your LLC’s registered agent can be an LLC member or an external third party that meets state requirements. For example, a registered agent may be an individual outside the company, an attorney or other legal professional, or an authorized company that proffers registered agent services.
LLCs are usually not required to have an operating agreement, but it’s best to have one in your records. Without one, state laws apply by default, and asset distribution may have to be settled in court.
The operating agreement should detail an LLC’s:
- Ownership and management structure and roles
- Each member’s rights and responsibilities
- Rules for meetings and voting
- Voting rights of each member
- What happens when a member sells their interest, becomes disabled, or dies
What Are the Advantages and Disadvantages of an LLC?
An LLC is a popular business structure for startup companies, presenting members with several benefits.
An LLC is considered a “pass-through entity” in terms of taxation, meaning that the LLC itself is not taxed. Instead, income passes through the company to the LLC owners or members, who report it on their tax returns.
Alternatively, LLCs can choose to be taxed as a corporation.
LLCs also offer flexibility in management, as there are few requirements regarding organizational structure. LLCs can be managed by members or managers, though most are member-managed.
- In a member-managed LLC, members handle all management duties. Member-managed LLCs generally work best for LLCs with few members, all of whom can take an active role in day-to-day operations.
- In a manager-managed LLC, non-member employees oversee operations and management duties. Manager-managed LLCs are best for LLCs with multiple members, some of whom want to be “silent” or passive members and not involved in day-to-day operations.
LLCs provide personal liability protection, which means that your assets are not at risk if your business ever gets sued or cannot pay back its debts. The owner of an LLC can also transfer assets other than those that are business-related into the LLC.
LLC operating agreements can be a great tool to simplify the transference of assets to heirs, avoiding the probate process. This is because the provisions of an operating agreement should specify what happens if the business owner passes away.
Family LLCs: What Are They?
A type of limited liability company, family LLCs are recognized by the state and owned by family members that are related by blood, adoption, or marriage. In this LLC structure, a family member is the same as an LLC member, but only one family member identifies as the manager.
Like a traditional LLC, a family LLC’s operating agreement will specify the business’s ownership structure and management roles, as well as how assets will be transferred to heirs upon the death of the LLC owner.
Family LLCs are a popular business structure used to safeguard assets from liability, such as real estate or brokerage account assets. Assets are protected from creditor claims, but only to the extent of each member’s financial contribution to the LLC.
Family LLCs cannot manage a personal residence, but this structure is often used to facilitate estate planning due to its significant advantages. For instance, in addition to asset protection, heirs can avoid the probate process during asset distribution.
Furthermore, heirs stand to benefit from reduced taxes related to assets. For example, with a family LLC, heirs’ estate tax liability is usually significantly lessened when assets are transferred, as taxes can be reduced by up to 40% of their market value.
Similarly, if a business owner moves assets into the family LLC and wishes to distribute their assets to heirs while still alive, the associated gift taxes can also be reduced.
Trust vs. LLC and Family LLC
Which is best for you and your business?
Establishing a trust is much easier than forming an LLC, so if you’re interested in getting it done quickly, that might be your preference. But, of course, the purpose of a trust is much more narrow – they tend to be about protecting assets rather than making profits.
If you want to start a profit-making business, an LLC is a way to go! And if you’re looking to start a business with family members, we encourage you to consider a family LLC.
If your primary focus is protecting your assets, then you should first evaluate what those assets are. As you may be able to guess, if your assets are primarily business-related, then forming an LLC is likely your best choice.
Trusts are better suited for estate planning and reducing estate taxes. However, trusts are also highly personal and private, as the trust document is not filed with the state. In comparison, LLC formation documents are filed with the state and are often publicly accessible.
Keep in mind that trusts and LLCs are not mutually exclusive. For example, an entrepreneur can create a trust, then use it to create an LLC by listing the trust as an LLC owner on the articles of the organization.
When distributing assets to the designated heirs, all three entities support avoiding the probate process. However, there are also some slight differences in executing asset distribution among the three that are important to pay attention to.
A trust’s assets are distributed to heirs according to the trust document. The operating agreement should detail how LLC assets are distributed to beneficiaries.
Family LLCs, however, offer additional benefits by reducing heirs’ liability for asset taxes. Any assets distributed from a living family member are eligible for a gift tax reduction, and estate taxes can even be reduced by up to 40% of their market value.
Another element to consider is the cost of maintaining a trust versus an LLC. Trusts are typically created with the assistance of a legal professional, a service that will undoubtedly present a fee. But once the document is done, that’s it!
LLCs, on the other hand, carry multiple fees. Some are a one-time occurrence, while others are annual. In addition, you’ll pay to file your articles of organization and for regular reports and taxes.
If you wish to reserve the name you want to use for your LLC, you might have to pay your state up to $100. In addition, to conduct business legally, you may need to acquire and renew business licenses at the local, state, and federal levels.
LLCs often require more than one license so that the fees can add up! Thus, it’s important to research the expenses your LLC would be subject to, as this can significantly influence your decision. If you’re short on resources, forming trust might be wise.
To Sum Up
When deciding how to protect your assets best, choosing the entity type that fits your needs and your business is essential. Be sure to pay attention to each structure’s primary purposes and advantages, and carefully select the option that best aligns with your goals.
We recommend consulting with an attorney or tax advisor, if you’re still unsure as to what your next move is.
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