Academic journal article Journal of Business and Entrepreneurship

Can Small Business Still Receive Tax Benefits from Educational Benefit Trusts?

Academic journal article Journal of Business and Entrepreneurship

Can Small Business Still Receive Tax Benefits from Educational Benefit Trusts?

Article excerpt

ABSTRACT

Two people want to start accumulating funds to pay for their children's college expenses. They would like to devise a plan in which their corporation would contribute funds to an educational benefit trust (EBT), and the contributions would be deductible by the corporation. At the same time, they would like to have the money distributed to the children for their college expenses to be nontaxable as scholarships or, if taxable, taxable to the children. This paper is concerned with the answers to several questions which would affect the desirability of establishing such a trust.

INTRODUCTION

Joe Executive and Tom Commerce are the only stockholders of a small corporation. They are the only employees of the business firm although they plan to hire more employees when the company becomes large enough to warrant more workers. Joe and Tom both have school age children. Joe and Tom want to start accumulating funds to pay for their children's college expenses. They would like to devise a plan in which their corporation would contribute funds to an educational benefit trust (EBT), and the contributions would be deductible by the corporation. At the same time the monies distributed to the children for their college expenses would be either nontaxable as scholarships or, if taxable, taxable to the children. If the children are to be taxed, of course, they would most likely be paying taxes at a much lower rate or not at all.

Joe and Tom have several questions to ask their accountant or tax attorney: Can they devise such a plan that would be both legitimate and economical? If the contributions to the trust by the corporation are deductible, when can the corporation deduct the expenses? If the benefits received from the trust are taxable, to whom are they taxed and when are they taxed? Would an educational benefit trust be beneficial to Joe and Tom? What effects, if any, would the new tax laws have upon EBTs?

LEGITIMACY AND THE ECONOMIC FACTOR

In answer to the first question, the tax advisor for Joe and Tom would probably inform them that an educational benefit trust could be established for them that would be both legitimate and economically worthwhile. Joe and Tom should select d competent trust attorney who has experience in designing and establishing trust plans and who will take the time to design a plan that will fit their needs and objectives. The attorney will, assumablv, know that particular state's rules and regulations concerning trust plans, ana he or she will create the plan accordingly.

Joe and Tom will also need to select a competent party to handle the trust-an investment firm, a bank trust department, or some other financial institution. Joe and Tom should primarily be interested in choosing a fiduciary who has sufficient experience in handling trusts and a successful track record for investing funds for trusts.

There appears to be a rather large range for legal fees both for drawing up a trust instrument and for handling a trust. Thus it would be advisable for the prospective grantors of a trust to "shop around" for reasonable fees.

With the selection of a competent attorney to write the trust plan and a competent fiduciary to manage the trust, Joe and Tom can feel confident that they have a legitimate trust. Whether or not the trust would be economically worthwhile will depend, to a certain extent, on how successful the trustee is in investing the trust's funds. Assuming the trustee has more investment expertise and capability to obtain higher rates of return (due to larger purchases in conjunction with investments from other trusts) than Joe and Tom would have, the trust should be an economical investment. Even if the taxability and deductibility factors (as discussed later) are not as favorable as Joe and Tom would like, an educational benefit trust would likely still be a better economic vehicle for corporate employees to fund their children's educations rather than to pay the entire educational costs directly out of their own pockets or out of a savings account. …

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