In NH, trusts and LLCs don’t mix

John Cunningham

Many competent New Hampshire estate planning lawyers advise their clients who are members of LLCs to hold their memberships in trusts. As I’ve already mentioned in a few columns, this is usually a bad idea, and using a trust to conduct a business is usually an even worse idea.

But since these uses of trusts are widespread in New Hampshire, I want to devote an entire column to the subject of trusts vs. LLCs – what you should know about this subject if you are a New Hampshire business owner, an LLC member or an estate planner.

A trust is a contractual arrangement under which one or more persons, called “grantors” or “settlors,” form a trust, contribute assets to it for the benefit of named trust beneficiaries, and formalize these actions in a written contract—called, somewhat misleadingly, a trust “instrument” — and identify in that contract the person or persons who will manage the trust assets for the beneficiaries’ benefit.

In New Hampshire, the laws governing trusts are the New Hampshire Uniform Trust Act (UTC) and numerous New Hampshire trust cases.

An LLC is not a contractual arrangement. It is a statutory business entity not formed under or governed by an “instrument,” but rather by an LLC statute and New Hampshire LLC case law.

In New Hampshire, this statute is the Revised New Hampshire Limited Liability Company Act. LLC founders form their LLCs by filing official documents called certificates of formation with the Division of Corporations of the NH Secretary of State. The New Hampshire LLC Act contains roughly 300 provisions, most of which are either “mandatory” provisions, which LLCs and their members cannot alter; and “default” provisions, which they are expressly permitted to alter in operating agreements.

The NH probate problem

When New Hampshire residents die, their assets pass to their heirs under their estate planning documents or, if they have no estate plan, under New Hampshire statutory law – but, with limited exceptions, only to the extent approved by a New Hampshire probate court.

Under New Hampshire probate procedures, a court may well withhold approval of asset transfers for many months, probate procedures often require many documentary submissions and hearings, and probate legal and accounting fees may amount to many hundreds of dollars and, especially if there are probate arguments among possible heirs, to many thousands of dollars.

However, New Hampshire probate applies only to assets left to heirs by will or statute and not to assets left by trust. Thus, New Hampshire estate planners generally advise their clients to avoid probate by conveying all of their valuable assets to their trusts. This often includes not only their homes but also, if they have any, their LLC memberships.

However, for two major reasons, New Hampshire LLC members should not hold their memberships in trusts:

First if the LLCs are multi-member LLCs taxable as partnerships — by far the best federal tax regimens for most multi-member LLCs — their LLCs will be subject to the harsh new Internal Revenue Code audit rules that became effective on Jan. 1, 2018, unless they qualify for exemptions to these rules.

Second, all of these trusts may be subject not only to the New Hampshire LLC Act but also, on many key legal issues, to the UTC. However, the UTC was not designed for the holding of LLC memberships and to govern trust managers or members in exercising LLC membership rights.

By contrast, the New Hampshire LLC Act was designed specifically for the above purposes, and the drafters of the New Hampshire LLC Act took great pains to ensure that the default rules of that act would address as usefully as possible the roughly 150 legal issues likely to be important to these members if they didn’t address them in written operating agreements. (The members of most New Hampshire single-member and multi-member LLCs don’t have written operating agreements.)

For essentially the same reasons as those outlined above with regard to the holding of LLC memberships in trusts, it is even more important that New Hampshire businesspeople not conduct their businesses as trusts. The UTC was not designed for this purpose – it is silent about most or all legal issues likely to be important to New Hampshire business owners – and at least a few UTC rules may be positively harmful to these business owners and their businesses.

By contrast, the drafters of the New Hampshire LLC Act did all they could to make the New Hampshire LLC Act as user-friendly as possible to New Hampshire business owners and to address in their interest all legal issues that might possibly be relevant to them.

John Cunningham is an attorney of counsel to the law firm of McLane Middleton whose practice is focused on LLC law and tax. He can be contacted at lawjmc@comcast.net, 603-856-7172 or llc199A.com.