A federal tax court’s ruling in favor a trust on certain deductions that the trust claimed on its federal income tax returns highlights a potential added bonus to the use of trust planning, as the court decided that a trust could engage in the sort of active participation in a business needed to claim the business’s losses on its taxes. By refusing to foreclose trusts from claiming the losses of trust-owned business assets, the court’s ruling offers one more reason why family farmers and small businesspeople should ensure they have a proper estate plan in place that includes their business holdings.
In 1979, Frank Aragona created a trust where he was the grantor and the original trustee, with his five children and one unrelated person serving as the trust’s six successor trustees. This setup might sound familiar, as many living trusts created as part of an estate plan often have the grantor serve as the initial trustee, with family, friends or a trusted professional serving as the successor trustee(s).
Aragona died two years after creating his trust, having funded some rental real estate properties, as well as some other real estate assets, into the trust. His successor trustees managed the properties, some directly owned by the trust, with others owned by LLC that was itself wholly owned by the trust. The use of LLCs within an estate plan is also a potentially helpful technique, offering important advantages in terms of establishing protection between various assets. Through this type of planning, a liability risk related to the LLC-owned real estate (such as, for example, a slip-and-fall injury on a LLC-owned property) will not expose all of the trust’s assets in the event of an unfavorable court judgment.
On the trust’s tax returns in 2005 and 2006, the trustees attempted to claim deductions related to losses incurred by the rental real estate properties. The Internal Revenue Service decided that the trust could not claim the rental real estate losses because, it argued, trusts cannot engage in the sort of active participation and control of a business necessary to take the deduction. The US Tax Court, whose rulings are applicable in all states, sided with the trust and said that it was possible for trusts to engage in the necessary degree of participation in the business and, as a result, claim the business losses on its taxes.
The case is potentially very beneficial for small business owners considering engaging in estate planning. In addition to the considerable benefits of planning for your small business when you create an estate plan, including the establishment of a succession plan and probate avoidance (among others,) this ruling also creates an additional tax advantage for your family. The ruling means that if you create a trust to manage your business even after your death, your trust may be able to take advantage of some of the same tax rules regarding business losses as if an individual person owned them.
Estate planning is a must for everyone, but nowhere is the need greater than in the community of family farmers and other small business owners. Having a plan for your business within your estate plan can help you guarantee that your life’s work will continue, will progress seamlessly after you die, and that your successors can take full advantage of the tax code’s rules related to businesses. To discuss planning for your family and family business, talk to Madison estate planning attorney Daniel J. Krause of Estate Law Partners, LLC. He can help you put together the most cost-effective and sensible plan for your family and business. Contact Attorney Daniel J. Krause today.
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