Should I put my business in a trust to save on estate taxes?

Growing your wealth through a small business is very rewarding. Preserving that wealth for your family requires careful estate planning and sound decisions. If you expect the business to grow significantly over time, putting it in a trust in its early stages can result in significant savings on estate duty when you die.

Despite this obvious benefit, the decision should not be taken lightly, as there are many other implications. Carefully consider the pros and cons before making a final decision.

What happens to your business when you die?

The legal structure of the business determines how it is dealt with in your estate.

• If you are a sole proprietor, the business will be liquidated, assets sold and debts settled. The remaining funds will form part of your estate and potentially be subject to estate duty.
  
  
• If you own shares in the company, they will be included in your estate and sold, either to an outside party or to the remaining shareholders if there’s a buy-and-sell agreement in place and they have means to fund this.
  
  
• If the business shares are owned by a trust, the trust retains ownership of the business, and the business is excluded from the estate, except for any loan made by the founder to the trust.
  
  

What are the benefits of placing your small business in a trust?

• It ensures business continuity

A trust is managed by professional trustees, so the business can continue and your dependents can benefit financially from the business without having to get involved or making any business decisions.

• There is no estate duty on the growth in the shares in the business.

Placing your small business in a trust can be beneficial if it is done when the value of the shares in the business is low. The business and value of the shares will grow over time, but the growth that happens in the trust will not attract estate duty in your estate.

As a trust is unlikely to have the funds to buy the shares in the business outright, business owners typically make a loan to the trust equal to the value of the business when it is sold the trust.

This loan cannot be interest free so it will attract interest, and if the trust does not pay the interest, the loan account will also grow. As a business owner, this loan account will be an asset in your estate, and when you die it may attract estate duty.

You can, however, reduce the loan annually with a donation to the trust.

What are the drawbacks of placing your small business in a trust?

When you place any asset into a trust, you give up control of that asset and it is instead controlled by the trustees.

• You hand over control of your business.

When you place any asset into a trust, you give up control of that asset and it is instead controlled by the trustees. As the business owner, you can be one of the trustees but you cannot have the final say or the trust may be regarded as a sham.

This makes decision-making more complex; while you will continue to manage the business as the managing director, decisions like when to sell shares will be made by independent trustees.

This is not a problem as long as everyone agrees when making business decisions. Potential issues could arise if you want to sell the business but cannot agree on the selling price. Independent trustees must consider their professional liability when setting a selling price, which may differ from yours.

• You forfeit capital gain benefits when you sell.

When your business is sold you may be liable for capital gains tax on the gain you have made.

If you own your business in your own name and you want to sell it, perhaps to retire, you may enjoy a R1.8 million exemption from capital gains tax if:

The business is worth R10 million or less.

The owner is at least 55 years old or is selling due to ill health or death.

The business is owned by a natural person.

In order to enjoy this exemption, the business must be owned by you as a natural person. If you put the business in a trust, you will lose this exemption and when the business is eventually sold, it could result in a higher tax liability.

• You incur capital gains and other tax liabilities.

When the trust is set up and you sell your share of the business to the trust, you will incur a capital gain that is taxable in your personal capacity. In addition, if you sell the business to the trust using a loan to the trust, the loan account will attract interest at a rate of prime plus 1%.

If this interest exceeds the annual interest exemption, you will be taxed on this at your marginal tax rate. If the trust cannot pay this interest, the loan account will also grow and attract more interest.

Trusts pay income tax at the highest tax rate, while individuals pay tax at their marginal tax rate and companies at the company tax rate.

When you start a business, you have no idea how big it will grow, so it’s tough to decide on what legal structure to implement. Get professional advice, weigh up the options vigorously, and carefully consider the pros and cons. There is no one-size-fits-all solution, and you must make an informed decision, considering all the implications.