Succession & Estate

Trusts That Hold Business Interests

Solve the specific problems a trustee faces holding a single illiquid operating company — the diversification duty, the impartiality problem, the S corporation eligibility trap, and who actually makes business decisions.

  • Advanced
  • 9 min total
  • 12 chapters

What decision this helps you make: How to draft and administer a trust that will own a closely held business, and how to allocate authority between the trustee, an investment director, and the family.

What this topic is

A trust holding an interest in a closely held business faces a set of problems no diversified portfolio trust encounters. The asset cannot be sold, may produce no cash, requires business judgement rather than investment judgement, and sits inside default fiduciary rules that were written on the assumption a trustee could and would diversify. This lesson covers the drafting and the administration that make such a trust workable.

Why it matters

Every transfer technique in this section ends with a trust owning a business. If the trust instrument does not address retention, distribution standards, who directs business decisions, and the entity tax elections, the structure that took a year to build becomes unmanageable in its second year. Trustees resign, beneficiaries sue, and in the worst case a single defective election terminates a pass-through status for every shareholder in the company.

Who should learn it

Owners establishing trusts to hold business interests, trustees who have been handed one, beneficiaries trying to understand what the trustee may and may not do, and advisers drafting the instruments.

What you will understand

  • How the duty to diversify collides with a concentrated business holding, and the three ways to solve it
  • The impartiality problem between beneficiaries who want cash and those who want growth, and the tools that address it
  • The S corporation eligibility rules for trusts, and the elections that must be made on time
  • How directed trust structures separate business decisions from administrative ones

Prerequisites

Common misconception

"We put the shares in trust, so the family is protected." A trust is a set of duties owed by one person to others. Putting an illiquid, non-distributing, concentrated business into it creates a person legally obliged to act prudently and impartially with respect to an asset that is none of those things. Without express retention authority, a distribution standard that works when there is no cash, and a clear allocation of business decision-making, you have not protected the family — you have given a professional a problem they may respond to by selling the company.