Nevada Business Trusts are great tools for investment types of business ventures (although they are not limited to investment fund), governed by NRS Chapter 88A. To understand a Nevada Business Trust, one needs to have a basic understanding of what a standard legal trust is.
Trusts are an investment and asset protection tool. A typical example is when parents set aside funds for their children's education. Or, perhaps parents want funds available for their child when their child turns thirty to help care for their grandchild.
To do so, the parents need only to form a trust (no formal document is required; the parents express their intention for a trust to exist NRS 164.700). The parents are the “trustors” (the people creating the trust). The trustors fund the trust and hire a "trustee". The trustee's job, usually for a fee, is to maintain trust assets, reasonably invest those assets, and properly distribute trust funds according to the trustors' wishes. The children, in this scenario, are the “beneficiaries,” the people entitled to the trust assets once they turn thirty.
Nevada trusts can become more complex per the trustors' wishes. For instance, perhaps the parents only want trust assets distributed to their children if the children are thirty and have their own children. Or, maybe they want the assets to be allocated for their grandchildren's education, and the trustee determines when to make distributions. In sum, trusts accomplish any of the trustors' wishes.
Nevada Business Trusts operate in the same manner as legal trusts, but as the name suggests, are utilized for commercial purposes, usually for investment type of commercial activity.
To illustrate, imagine four business partners want to form a real-estate investing venture. However, the partners are only interested in passive investing and do not wish to be involved with the day to day business decisions.
To do this, they could form a Nevada Business Trust. Each partner agrees to contribute $250,000.00 as trust assets. They hire a financial manager as the trustee. The trustee decides which properties to buy and sell. The partners then deem themselves the beneficiaries of the Nevada Business Trust. The partners can also agree to terms of when they are entitled to trust benefits; perhaps on a fixed date in 5 years the assets are distributed, or maybe the trust works like an annuity, or maybe the funds are only distributed once the assets obtain a particular value; the possibilities are endless. These possibilities determine both how assets are managed and distributed to the partners.
As you can see, Nevada Business Trusts are a great tool for business owners interested in passive investing and who do not want to be involved with the day to day affairs. In addition, Nevada Business Trusts offer tax benefits as well.
Tax Considerations:
Dragon Law Group highly recommends a business seeks the advice of a certified accountant when making determinations on tax consequences of business formation because it can become very complicated. The type of entity utilized by business owners in Nevada does not necessarily mean the IRS will tax that entity as labeled. The IRS uses its criteria in determining how to tax entities and does not defer to state law.
Nevada Business Trusts are taxed based on the interest generated from its assets. Either the trust itself or the beneficiaries will be taxed depending if the trustee distributes income to the beneficiaries. Beneficiaries are not taxed on funds derived from the business trust's principle but, instead, are taxed on any interest or profit made. The interest might be taxed at the lower capital gains rates if specific criteria are met.
There is an essential element to Nevada Business Trusts regarding tax advantages. There are two types of trust: revocable trust and irrevocable trust. Don't let the legal terms confuse you; all you need to know is that an irrevocable trust occurs when the trustors cannot amend the trust agreement. Using the parent example to illustrate. Imagine that the parents form a trust for the benefit of their children, once their children turn 30. If the trust agreement dictates that the trustee must distribute the assets to the children no matter what, then the trust is irrevocable because the parents cannot amend the terms. But, on the other hand, if the parents reserve the right to cancel or amend the trust, the trust is revocable because the trustors have the power to amend it. Whether a Nevada Business Trust is irrevocable or non-irrevocable has specific tax consequences.
The IRS taxes a Nevada Business Trust as a trust, only if it is a non-revocable trust. If the Nevada Business Trust operates as a revocable trust, then it is likely the IRS will tax it as if it is a partnership, meaning the trustors are taxed since they have control of the funds. The more the beneficiaries have control over the trust assets and operations (or the more likely it is a revocable trust), the more likely the Nevada Business Trust will not receive trust treatment. 26 CFR § 301.7701-4(b)
That said, Nevada Business Trusts, on the date of formation, can elect to be taxed as partnership or LLC, even if it is a revocable trust. 26 CFR § 301.7701-3(c). There may be strategic tax reasons to do so; therefore, the trust should seek counsel from an accountant.
On a final note, Business Trusts enjoy the same limited liability principle of other Nevada entities, so the beneficiaries enjoy the same type of protection.
Take Away:
Nevada Business Trusts are fantastic legal tools for investment types of business. Before forming one, advice from a Nevada Attorney such as Joe Dragon of Dragon Law Group and an accountant is critical to ensure the Nevada Business Trust is valid under Nevada law and that it will be taxed appropriately by the IRS.
Should you have any questions, please do not hesitate to contact us.