Revocable trusts have been popularized by estate planning advisers because they convey advantages relative to probate costs. However, despite marketing schemes touting the benefits of revocable trusts, they have significant drawbacks in terms of asset vulnerability and taxation. When a revocable trust is the sole member of a Limited Liability Company, the negative aspects of the revocable trust may taint all property in the LLC.
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A trust is a legal entity that holds property to be managed by a trustee for the benefit of others. A revocable trust is a form of trust, which allows the grantor, or person creating the trust, to withdraw property or terminate the trust at any time before his or her death. Once the grantor dies, the trust becomes irrevocable, and cannot be changed. Revocable trusts are often recommended by estate planners, because the assets placed within the trust do not have to go through probate; they simply get distributed to the beneficiaries of the trust. Revocable trusts also share some of the characteristics of a durable power of attorney, allowing a trustee to manage assets when the grantor has become disabled or incompetent. Revocable trusts can also be used in a manner similar to a will to name guardians for minor children.
Single Member LLCs
Limited liability company formation and requirements are matters of state law. Although early LLC laws required two or more members to form an LLC, all states now allow single-member LLC formation. Although a single-member LLC is usually taxed as a separate entity under state law, it can be considered as a disregarded entity under federal tax law. For federal income tax purposes, the Internal Revenue Service only looks to the owner of the LLC and not on the LLC itself. While state laws differ, most states allow the sole member of an LLC to be a 'person' as defined by state statute, and in most states that means that a corporation, partnership or trust -- including a revocable trust -- may be the sole member of an LLC.
Unlike many other forms of trust, assets placed in a revocable trust are not protected from creditors. Because the grantor does not give up control of the assets placed in a revocable trust, those assets are still legally considered the personal property of the grantor. All assets in an LLC owned by a revocable trust as a single member are therefore vulnerable to the grantor's creditors. As discussed by the Indiana Department of State Revenue, ruling a single-member revocable trust owned LLC does not relieve the grantor of individual responsibility for the taxes, fees and liabilities associated with the property placed in that trust. While a revocable trust can be the sole member of an LLC, such a configuration will not protect the assets of of that trust or the LLC.
While revocable trusts are rife with negative consequences in most business and estate planning situations, there are scenarios in which using a revocable trust as a sole member of an LLC may have some limited advantages. Revocable trusts and LLCs can serve as asset-combining and organizing tools for couples who, for legal or personal reasons, cannot lawfully marry, according to the DuPage, Illinois County Bar Association. Operating through an LLC, an unmarried couple can share a bank account, and can purchase and hold assets in a manner similar to that of married couples. If both members of the couple have personal assets going into the relationship, they may each choose to put their own assets in a revocable trust, and create an LLC -- of which both trusts are members. If only one person of the couple has assets, a single-member LLC comprised of one revocable trust where both members of the couple are trustees or serve as managers of the LLC, can still establish a joint legal entity for the couple.
References & Resources
- The Journal of the DuPage County Bar Association: Cohabitation: What to Do When Couples Cannot or Do Not Marry
- Internal Revenue Service: Trusts: Common Law and IRC 501(c)(3) and 4947
- Indiana Department of State Revenue: Letter of Findings No. 04-5120238NRA
- Oklahoma Bar Association Journal: Using One-Member LLCs as 'Disregarded Entities'
- State Bar of Wisconsin: Revocable Living Trusts: Answering Your Legal Questions
- Broward County Bar Association People's Law Guide: Is a Revocable Living Trust Right for Me?
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