Family Trusts explained and Family Trust Elections explained
The term family trust refers to a discretionary trust set up to hold a family's assets or to conduct a family business. Generally, they are established for asset protection or tax purposes.
The importance of Family Trust Elections are explained below under the heading "Family trust elections — a word from the ATO on income distributions".
What is a Family Trust in Australia?
An Australian family trust:
- is generally established by a family member for the benefit of members of the 'family group';
- can be the subject of a family trust election which provides it with certain tax advantages, provided that the trust passes the family control test and makes distributions of trust income only to beneficiaries of the trust who are within the 'family group';
- can assist in protecting the family group's assets from the liabilities of one or more of the family members (for instance, in the event of a family member's bankruptcy or insolvency);
- provides a mechanism to pass family assets to future generations; and
- can provide a means of accessing favourable taxation treatment by ensuring all family members use their income tax "tax-free thresholds".
A family trust has many other potential benefits, including avoiding issues such as challenges to the will following a death of a senior member of the family.
The terms and conditions under which a family trust is established and maintained are set out in its deed.
The trust is established by the trust's settlor and trustee (or trustees) signing the trust deed, and the settlor giving the trust property (the "settled sum") to the trustee.
The settlor's function is to give the assets to the trustee to hold for the benefit of the trust's beneficiaries on the terms and conditions set out in the trust deed. The settlor executes the trust deed and then, generally, has no further involvement in the trust.
The trustee is responsible for the trust and its assets. The trustee has broad powers to conduct the trust, and manage its assets.
In a family trust, the trustees are usually Mum and Dad (or a company of which Mum and Dad are the shareholders and directors). Their children and any other dependants are usually listed as beneficiaries.
Family Trust income
One of the key benefits of a family trust is that the trustee can distribute income earned by the trust [from the trust property] in any way they see fit, provided distributions are made to people who qualify as beneficiaries. They do not have to make trust distributions in any particular proportion or in the same proportions as they did in previous years.
A trust does not have to pay income tax on income that is distributed to the beneficiaries, but does have to pay tax on undistributed income. The trustee is free to distribute trust income to as many beneficiaries as possible, and in proportions that take best advantage of those beneficiaries' personal marginal tax rates. The beneficiaries then pay the tax on distributions made to them.
For example, if an adult beneficiary of the trust only receives income from a trust and has the benefit of the tax-free threshold (currently $6,000) for the year, the trustee could distribute part of the family trust's income to this person. The result is that the beneficiary will receive some income but may not have to pay tax if that amount is less than $6,000. If the distribution to the beneficiary exceeds his or her tax-free threshold, the excess amount will be taxed at the beneficiary's personal marginal tax rate.
Distributions received from a trust is not a special form of income, but instead forms part of a beneficiary's assessable income. If the beneficiary receives income from other sources in addition to distributions from the trust, all of the income will be taxed together.
Even if the beneficiary's income does exceed the tax-free threshold for a particular year, the rate of tax applied to the amount of the excess income over the tax-free threshold may be lower than for other beneficiaries because of the total income that these other beneficiaries already receive.
Undistributed income is taxed in the hands of the trustee at the top marginal tax rate of 45% for the 2006/2007 year, giving a strong incentive to family trusts to fully distribute the trust's income before the end of each financial year.
The trustee should also take care in relation to which beneficiaries are chosen to receive distributions, as penalty tax rates can apply to distributions made to minors.
Family trust elections — a word from the ATO on income distributions
One important aspect of a family trust that must be kept in mind is to whom the distributions are made.
First, all distributions must be made only to people who qualify under the terms of the trust deed to be beneficiaries of the trust.
Secondly, for trusts that have made a family trust election, the distributions may only be made to beneficiaries who are within 'the family group'. In relation to this the ATO states on its website:
"A consequence of making a family trust election is that any distributions (broadly defined) outside the family group of the family trust by the trust will be taxed at the top marginal rate applying to individuals plus the Medicare levy."
In other words, if a family trust makes a family trust election and then pays out to someone not a member of the family group, they will be taxed at the maximum rate possible! Be warned...
Seek legal advice — especially about Family Trust Elections
The family trust information here should be considered general in nature, and in no way interpreted as legal advice. You should always seek your own independent legal, accounting and financial advice before ordering any of these types of complicated legal structures.
Click here to set up your own family trust.To update your family trust, you can do this through a Change of Trustee Discretionary Trust. For further information on trusts, you can read a wide range of ClearLaw articles.