What Are the Benefits of an S Corporation Vs. a Family Trust?

By John Cromwell

Many families consider placing some of their personal assets into a separate legal entity as part of their estate planning. Surrendering ownership of property would exempt those assets from the prior owner's probate estate. When the original owner dies, those assets can be distributed to his chosen beneficiaries without being delayed by probate. If done correctly, you can surrender ownership of the property but can continue to use the assets for the rest of your life. Two legal entities that families can use for this purpose are trusts and S corporations. Trusts and corporations are regulated by state law, so the processes for starting a trust and incorporating may vary.

Control of Assets

One advantage an S-Corp has over a family trust is flexibility regarding control of the assets. A trust operates under a trust agreement, which identifies a trustee to manage and distribute the assets. The trustee must comply with all of the agreement’s terms regarding how the assets are to be distributed. If the trust is revocable, the person who created the trust can amend the terms of the trust or choose a new trustee at any time; if the trust is irrevocable, the creator of the trust and all of the beneficiaries must agree to any change. In comparison, an S Corporation is organized under bylaws. The corporate officers are not restrained in terms of how they managed and distribute the corporate assets. The officers can be replaced at any time by taking a vote of the current shareholders and meeting the minimum vote requirement defined in the bylaws.

Taxing Profits from Assets

Depending on how the trust is organized, an S-Corp may provide tax advantages that a trust does not. If the trust is revocable, any income that the assets generate must be included on the trust creator’s tax return and are taxed at his personal tax rate. Profits from S-Corps, on the other hand, are divided amongst the shareholders based on their percentage ownership of the business. Each shareholder then reports and pays taxes on their share of the profits. In these situations, presumably some of the shareholders will be children who make less money than their parents who created the S-Corp. As a result, some of the profits would be taxed at a lower rate with an S-Corp, where with a trust all of the income would be taxed at the parent’s higher rate.

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New Beneficiaries

Families can add new members and as a result, you may want to give new people access to the assets in question. With a revocable family trust, the creator can unilaterally add new members regardless of how the beneficiaries feel at any time. This could greatly depreciate the value of the trust. If the trust is irrevocable, all of the beneficiaries to the trust must agree to admit the new beneficiary. This could mean that no new beneficiaries ever join, regardless of the situation. With an S-Corp, the bylaws and restrictions on the distribution of shares can be drafted to ensure that family members can gain access to the assets without giving any one person the ability to add shareholders.

Formation Requirements

A significant disadvantage of an S-Corp is that there are formal requirements necessary to form one. A trust is created once the agreement is drafted and the property is transferred to the trustee to hold for the beneficiaries. To create an S-Corp, you must first incorporate in the state where you live. Then you must apply to the IRS to be recognized as an S-Corp. This can be expensive and time consuming process.

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Can a Trust Be a Share Holder of an S Corporation?

References

Related articles

Amending an Irrevocable Trust Agreement & Uniform Trust Code

Trust law varies based on the state where the trust is located. The Uniform Trust Code (UTC) is a proposed law meant to be enacted across the country to promote legal consistency regarding trusts. The UTC has been enacted in 23 states and covers most trust issues, including how to amend an irrevocable trust agreement. Under the UTC, an irrevocable trust agreement can be amended when the beneficiaries and creator agree to an amendment or when there is a significant change in circumstances surrounding the trust. When attempting to amend an irrevocable trust agreement, consider consulting with a licensed attorney.

Can a Trust Own an S Corp?

An S corporation is a business that elects to obtain a special tax status granted by the IRS. Most businesses that can be taxed as a corporation can apply to be taxed as a partnership, which is treated as a disregarded entity. Instead of the business paying taxes on its annual income, the profits and losses are divided among the shareholders to include on their personal returns. This enables the S-corp to avoid the “double-taxation” that a corporation faces. In exchange for these benefits, an S-corp is subject to several restrictions, including which entities can own shares in the business. Based on these restrictions, it is fair to question whether a trust can own S-corp shares.

Who Can Own an LLC?

Limited liability companies are among the most flexible business entities an owner can choose. LLC owners are called members, and one may be owned by an individual, a group or another business entity. Though LLCs are governed by state rather than federal law, there is a great amount of consistency among the ownership laws of each state.

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