Can a trust be a member of an LLC?

If an individual is looking to start a business that offers limited liability and probate protection, odds are they’ve come across the terms “LLC” and “trust” in their research. Each one could solve half of that problem, but it raises a question: can a trust be a member of an LLC?

The short answer is yes, but first, it’s essential to understand the relationship between LLCs and trusts. This guide will provide information about trust-owned LLCs.

Trusts Being Owners (Members) of an LLC

Yes, a trust can be a member of an LLC (an owner of an LLC is referred to as a “member”). So yes, a trust can own a limited liability company. In fact, a trust-owned LLC can be a valuable tool in estate planning.

Here’s how it works: an LLC is a business structure offering personal asset protection while avoiding double taxation. A trust is a legal arrangement in which a grantor transfers ownership of assets to a trustee to benefit one or more beneficiaries. Hence, entrepreneurs can enjoy the benefits of both legal entities by placing their LLC membership interests in a trust. 

Whether someone has a stake in a single-member or multi-member LLC, their LLC membership interests are treated as personal property. This means a person’s membership interest can be subject to probate upon their demise and could potentially be claimed by creditors. Therefore, it’s reasonable to have a plan to protect the LLC now and control what happens to the business in case of the owner’s demise or incapacitation.

LLCs and Trusts 

There are two ways to set up the trust ownership of membership interests in an LLC. They include an LLC revocable trust and an LLC irrevocable trust. 

What is an LLC revocable trust? 

An LLC revocable trust is set up in a way that the grantor still has control over the LLC. The grantor may withdraw assets from the trust. With a revocable trust, the trust can be terminated or changed during the grantor’s lifetime. 

In the event of the grantor’s death or incapacity, the terms of the trust determine what happens to the assets. Most times, the trust’s assets are distributed to the beneficiaries. In some cases, the trust continues to manage the assets and pays income to the beneficiaries. 

What is an LLC irrevocable trust? 

As the name suggests, an LLC irrevocable trust can’t be easily revoked or changed once created, although one can often still be modified by consent of the beneficiaries, by court order, or by decanting the assets into a new trust. In most cases the grantor gives up control over the LLC, but some irrevocable trusts let the grantor stay a permissible beneficiary and keep a limited set of powers, such as the right to veto a distribution or to remove and replace a trustee. Someone else is usually named the beneficiary. Giving up the income is not the same as giving up the tax: under the grantor trust rules, a grantor who retains certain powers is still taxed on all of the trust’s income, including the LLC’s profits, even when that money goes to other beneficiaries. Where the grantor keeps no control or access, the LLC membership interests are harder for the grantor’s creditors to reach, but that protection isn’t automatic. In most states a creditor can still reach the maximum amount that can be distributed to or for the grantor’s benefit, and the states that do allow self-settled asset protection apply a look back period to the transfer, so check your state’s rules and take advice before relying on it. 

However, there’s a form of irrevocable trust known as a domestic asset protection trust that lets grantors remain a permissible beneficiary and keep a limited, statutory list of rights, such as the power to veto a distribution, a power of appointment, or the right to remove a trustee and appoint a replacement. It does not let grantors keep control of the asset, because the trust has to be held by a qualified trustee who isn’t the grantor (see the domestic asset protection trust definition guide for more information). This means grantors can combine the creditor protection an irrevocable trust offers with a limited, statutory set of retained rights, but not the free control over the assets that a revocable trust would give them. Domestic asset protection is restricted in some states, but an individual doesn’t need to be a resident to set up a trust in a particular state.

Revocable Trust as a Member of an LLC 

The law will permit a person to transfer their membership interest to a trust, but the operating agreement might not. Hence, it’s imperative that an LLC member first confirms that the operating agreement accommodates this transition. If not, the member will need to seek the consent of other members or amend the operating agreement if they’re the sole owner. This section explores some of the benefits and drawbacks of having a revocable trust as a member of an LLC.

Benefits 

Avoiding the Probate Process

Probate is the legal process by which the court presides over the distribution of an estate when the owner dies. Aside from ensuring that a person’s business interests and assets are awarded to beneficiaries in their will, probate helps ensure their debts are settled. 

The probate period can last weeks or months. The deceased owner’s business interest is left unattended during this period, which increases the risk of operational problems. Placing membership assets in a trust can make the transition smoother and save beneficiaries from this strenuous process. 

Privacy 

An estate settled through probate is a matter of public record. This means that with some research, non-beneficiaries like disinherited heirs, creditors, and scammers can learn details about the estate. Since trusts cut out the entire probate ordeal, matters concerning the estate remain private.

Planning for Being Incapacitated

It’s great thinking when someone makes plans for how their business interests will be managed upon their demise, but sometimes that’s not enough. What happens when an unforeseen circumstance, like an accident or a medical condition, leaves the owner incapacitated? It’s possible to structure the LLC trust so that a trustee is authorized to take charge on the owner’s behalf if they’re incapacitated. 

Drawbacks 

Having a revocable trust as a member of an LLC can help a person’s beneficiaries avoid probate after the grantor’s death (see the member definition guide for more information). However, it doesn’t add creditor protection. As long as the grantor is alive and still controls the trust, the trust assets, including the LLC membership interests, can be reached by the grantor’s creditors. 

Another drawback to using this strategy is that it could be expensive. To execute this plan, a person needs to set up an LLC, which involves several expenses. Aside from the initial cost of filing Articles of Organization (see Articles of Organization definition), the owner needs to consider ongoing costs such as annual or biennial reports. Then they have to consider the cost of setting up and maintaining a revocable trust. See the annual reports definition page to learn more about those requirements.

In conclusion, establishing a trust-owned LLC can offer valuable protection for a person’s assets and ensure a smooth transition of business interests. However, it’s essential to consider other factors when structuring a business, such as ownership and employment options. For instance, someone may want to explore whether an S Corporation can own an LLC or if an LLC can own another LLC to further optimize the business setup.

If someone’s considering different organizational models, they may ask, can an LLC be a nonprofit? Or can an LLC member also be an employee? Answering these questions can help entrepreneurs decide which structure best suits their operational needs. Moreover, understanding how to adapt an existing business, like converting a corporation into an LLC or clarifying whether an LLC can have employees, will help entrepreneurs make the right choices for the long-term success of their venture.

ZenBusiness can help!

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