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Why the SBA doesn’t like your joint trust: A common estate planning trap for owners of certified small businesses with government contracts

It is common for business owners to have different attorneys for their estate planning needs and their business law needs – sometimes, the two attorneys don’t even work for the same law firm. This article will review the first of two instances where it is very important to make sure your estate plan documents are in compliance with federal regulations if you are an SBA certified, economically-disadvantaged small business (8a), woman-owned small business (WOSB/EDWOSB), or an SBA or VA certified veteran-owned small business (VOSB/SDVOSB).

Joint Trusts – an Estate Planning Perspective

First, a little background about the estate tax (or, “death tax”) and why many business owners historically set up trusts. As late as 2001, the federal estate tax exemption stood at only $675,000, and was not portable between spouses. And even as late as 2008, the exemption was only $2,000,000.

In order for a married couple to pay as little federal estate tax as possible, it is a common estate planning technique to set up “credit shelter trusts,” where each spouse is the grantor, trustee and beneficiary of their own individual trust. Each spouse’s trust would then have language about how distributions would be made to the other spouse in order to maximize allowable exemptions and minimize the estate tax (the exact details of which are beyond the scope of this article).

For example, if the husband owned a VA-certified business, we would put the stock of that company in his trust, and maybe the couple’s house and bank accounts in the wife’s trust.

Congress Raises the Exemption Level

But…on January 1, 2013, Congress permanently set the estate tax exemption level at $5,000,000, annually indexed it to inflation, and made any unused portion of the exemption portable between spouses. The effect in simple terms is that in 2016 a married couple would need over $11,000,000 in assets before paying federal estate tax.

As a result of tax planning no longer being a primary concern for most Americans, even for small business owners, it is now becoming commonplace for estate planning attorneys to simply set up a joint trust. Both spouses put all of their assets in the same trust, and they are the grantors, co-trustees and present beneficiaries of their joint assets inside the trust. This technique is much easier to administer, while still providing the other main purposes of a trust – avoiding probate court, and placing restrictions on when future beneficiaries can access the trust assets.

Joint Trusts – a Government Contracting Perspective

The SBA and VA administer several programs where government agencies can limit competition on contracts with the private sector to only certain certified business, in order to achieve Congress’ goal of providing more opportunities to historically underutilized demographics. But in order for a business to bid on these “set-aside” contracts, they must meet certain ownership requirements in the federal regulations.

As an example, in order to becoming 8a certified, “an applicant or Participant must be at least 51 percent unconditionally and directly owned by one or more socially or economically disadvantaged individuals who are citizens of the United States.” (13 CFR § 124.105)

The SBA and VA have very strict rules on what unconditionally and directly owned means, and will closely review an applicant’s business and personal records before certifying a business for 8a or VOSB status. And, as you have probably already guessed, there are even specific regulations on ownership by trusts.

Using the 8a regulations as an example again, they state: “Ownership by a trust, such as a living trust, may be treated as the functional equivalent of ownership by a disadvantaged individual where the trust is revocable, and the disadvantaged individual is the grantor, a trustee, and the sole current beneficiary of the trust.” (13 CFR § 124.105a)

The use of joint trusts for married couples is becoming increasingly common among estate planning attorneys, but my fear is that many clients who already own certified small businesses won’t be aware of the prohibition in the federal regulations regarding joint trusts when they meet with an estate planning attorney for the first time – and their attorney won’t be aware either.

Take-away Lesson for Joint Trusts

The SBA and VA take their regulations very seriously, and making ownership misrepresentations can subject a business owner to severe criminal and civil penalties. (15 USC § 645) There are also examples in the administrative case law where a business has been terminated from the 8a program for failure to disclose the existence of a trust.

Before signing any estate planning documents, small business owners with government contracts need to make sure their trust is compliant with federal regulations. If you own a business with federal government contracts and have any questions regarding setting up your estate plan, please contact Attorney Adam Zuwerink at or 231-457-4235.