Common Law Trust aka Business Trust Definition and Features
A business trust (also known as a common law trust) is a form of trust that is created explicitly to carry out certain business purposes. More generally, a trust is a set of assets or property which are overseen by a trustee or by multiple trustees, who hold the title to the business’s property in the name of the beneficiary or beneficiaries of that trust. A business trust is also subject to the various legal protections and responsibilities of businesses at large.
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What Is a Business Trust?
A business trust is a type of trust that is formed when a settler or donor appoints trustees to manage property and assets on the behalf of a beneficiary. The beneficiary is usually someone who can’t handle the assets on their own. For example, a child who has received ownership in a business as part of their inheritance.
Features of a Business Trust
A business trust has several defining features:
- Declaration of Trust: In order to create a business trust, the original property owner will create and sign a declaration of trust. A declaration of trust sets forth the terms of the business trust, including its duration, the powers and responsibilities of the trustees, and the interests of the beneficiary that the trustees should try to satisfy.
- Trustees: A business trust is governed by one or more trustees. A trustee is someone who has the authority to manage property and assets and act on behalf of the trust’s beneficiary. Anyone who takes on the role of a trustee has a fiduciary responsibility to the trust’s beneficiary, meaning that they are legally required to act in favor of the beneficiary’s financial interests rather than their own.
- Beneficiary: The beneficiary of a trust is named in the declaration of trust. This is the person who is meant to benefit from the actions of the business trust and its trustees. In the inheritance example above, the beneficiary would be the child who is not yet old enough to manage their inheritance, so those assets are managed by trustees on their behalf.
- Assets: The assets of a business trust are set forth in the declaration of trust. These are the assets or property that the trustees are asked to manage. An example of business trust assets might include stocks, cash, real estate, ownership in a company, or items of value. Depending on the terms in the declaration of trust, the trustees may have the rights to sell existing property, buy additional property, or try to expand the assets through business.
Trusts vs Partnerships and Corporations
A corporation is an entity that is chartered by the state in order to separate the legal obligations of a company’s shareholders and owners from the legal obligations and liabilities of the company itself. This is different from a business trust, which is created by a voluntary agreement among individuals.
Business trusts are also in a legal gray area compared to corporations. Depending on the state that you form your trust in, it may be subject to state laws governing trusts as well as to the laws governing corporations.
Trustees also differ from the partners in a limited liability partnership (LLP) because a certificate of trust, which designates a person as a trustee, is transferable. Furthermore, partners in an LLP can be held liable for the business’s debts, whereas, depending on the terms set forth in the declaration of trust, the losses suffered by a business trust are shared among that trust’s beneficiaries.
Business Trust Examples
There are three types of business trust that are used most often:
A grantor trust is a trust that is defined by three parties. A grantor, who provides the assets to be managed by the trust; a trustee, who manages those assets; and a beneficiary, who owns the eventual rights to those assets. A grantor trust is commonly used by wealthy people to set aside an inheritance for their children. While the child is still growing up, the assets are managed by the trustee. When the child has reached the age designated in the declaration of trust, they will gain access to and take over the responsibility for their inheritance.
A simple trust is a type of trust that is established by a business to oversee some of that business’s assets. A simple trust must meet the standards of the IRS, which state that a simple trust cannot keep the income that it produces by managing its assets. Instead, all of the simple trust’s income must go back to its parent business. Real Estate Investment Trusts often fit this definition.
A complex trust is similar to a simple trust insofar as they are both established by a parent company to oversee some of that company’s assets. However, unlike simple trusts, complex trusts are not required to return their income back to their parent company.
In some cases, a grantor can retain the right to revoke a trust and take back possession of that trust’s assets. In this case, the trust is called a revocable trust. The opposite case, where the grantor cannot reclaim the assets given to the trust, is called an irrevocable trust.
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Nick Cesare is a writer from Boise, ID. In his free time he enjoys rock climbing and making avocado toast.
This post was updated February 28, 2019. It was originally published January 22, 2019.