Tax Tips for Trusts

Whether you have a trust set up for investment or business purposes, there are some common elements to preparing the trust's tax return.

Contrary to popular opinion, a trust is not actually a legal entity; rather, it is a formal relationship between other entities, where one entity holds property for the benefit of another entity, which could be a business or individual.

Because a trust is not a person or business entity, its income is usually taxed differently, although this depends on the setup and type of the trust. But even though the tax return is different, many other administrative aspects are the same as for any taxpaying entity.

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Trust Administration

One of the most important administrative tasks to attend to is to hold a formal meeting before midnight on 30 June each year to document the basis of distributions to beneficiaries.

If you haven't already done this for the financial year, talk to us as soon as possible so we can check your accounts and advise you on the best arrangements for beneficiary distributions.

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Record Keeping

The other essential element of trust administration is record keeping. Although a trust may not be a legal taxpaying entity in the same way a person or business is, all records related to income and expenses must be kept for five years after lodgement of the income tax return.

Records for any property owned by the trust are particularly important. If a trust owns multiple properties, you'll need to separate income and expenses according to each property.

If the trust earns income from overseas interests or investments, all these records must also be kept. It's also essential to document capital gains, interest earned, and dividends received.

The trustee must keep records of the trust deed, trustee contact details, trustee resolutions, statements of assets and liabilities, all business contracts, and for employing trusts, all records relating to wages and superannuation.

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Trust Management

Trust management can be complex but well worth the time spent keeping good records to maintain asset protection, streamline the tax return process, and maximise the allowable tax deductions.

At Bonerath & Co., we help with record keeping, managing investments, checking trust deed compliance, and simplifying the administration. Talk to us now and start preparing for your next trust tax return.

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How are family trusts taxed?

Any trust income will generally be distributed to the beneficiaries who then pay tax at their personal marginal tax rate. With discretionary trusts, the trustee decides how the distributions will be made across beneficiaries. For example, a trust with three beneficiaries could see the income of the trust distributed as a 20/30/50 split, meaning each beneficiary receives a different amount. This is different to a unit trust (or fixed trust) which provides a fixed entitlement to each beneficiary. The ownership percentages are agreed upon when the trust is first set up, and this is how the distributions are made.

A discretionary trust allows the trustee to distribute the income in a way to minimise tax liability by taking advantage of each beneficiary's marginal tax rate.

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Discretionary trust distributions example

Consider Steve who is a sole trader earning $300,000 per year. With an assessable income of $300,000, Steve's tax liability is $111,667 with the highest marginal rate of 47%.

Steve's wife, Laura, helps out with the administration of the business, but does so without collecting a wage.

With a discretionary trust set up, Steve and Laura are able to receive equal portions of the earnings, taking home $150,000 each. This drops them into a lower tax bracket, with a tax liability of $43,567 each — a total of $87,134 tax liability for their family income.

By setting up a family trust, Steve and Laura were able to reduce their family tax liability from $111,667 down to $87,134. A tax saving of $24,533 per year.

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Rules to be aware of with family trusts

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Retained earnings

If the total of the trust's net income is not distributed to its beneficiaries by the end of the financial year, the trust will be required to pay tax at the highest personal marginal tax rate of 47%. If a family trust is used to reduce the marginal tax rate of the beneficiaries, this penalty rate for retained earnings could significantly increase the tax liability.

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Family trust distribution tax

If the trust makes a distribution to someone outside of the family group, the trustee will be required to pay the family trust distribution tax. The destribution is taxed at the top marginal tax rate of 47%, and the beneficiary is not able to claim a tax credit. This is an issue if you'd like to extend your business to additional shareholders who are outside of your family group.

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Capital gains tax

Family trusts must pay capital gains tax if a CGT event is triggered — for example, the sale of assets or an investment resulting in a capital gain. However, family trusts receive a 50% CGT discount for eligible assets. Any realised capital gains are distributed and included in the beneficiary's assessable income.

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How we can help?

If you're wondering what the most tax-effective structure is for your business, it's a great idea to seek tax advice and consult a professional.

If you need more advice on this issue, please contact our team.

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