A Trust Structure Can Lower Tax

High income earners should be utilising a trust to distribute income and lower their tax burden. Here’s what you need to know. 

It’s more common than you think for families with a high household income to set up trusts. Trusts allow you to minimise tax, by distributing income – and therefore tax obligations – across more individuals. 

Tax is a drag on returns, but it is unfortunately, unavoidable. There are different trust entities that you can utilise.  

One such structure is a discretionary trust. Trust structures can help redistribute income, and therefore tax obligations, amongst multiple people. The most common use of trusts is for families, where income from investments can be distributed to lower income earners. 

For example, we can consider a scenario with three people in a trust. There is two one income earners on the highest marginal tax rate, and two individuals with no income. The investment income redistributed across all trust members would result in a lower overall tax burden. 

There are several scenarios where a trust may make sense. These include a single income household with two adults, or a situation where children or elderly parents are dependent and reliant on your income. If the dependents are over 18 and in a lower tax bracket, a trust may be a way to share the tax burden and lower the overall taxes paid on any earnings. 

Trusts must distribute income in the same year that the income was earned – it cannot be carried forward. If there’s undistributed income for the financial year, tax must be paid at the highest marginal tax rate. Although it can distribute income, at trust cannot distribute any losses. The only way that these losses can be offset in the same year or carried forward to offset against future income. 

By the way, trusts can utilise the 50% capital gains tax discount after holding an asset for 12 months. 

Management 

Trusts require management. They have a separate tax return and obligations to be managed and must follow the rules and responsibilities set by the deed in the trust. 

Note that the distribution of income is not tax effective to those under 18 as they have different tax treatments. This has been purposefully set up to discourage minors from taking on trust distributions to lower tax burdens.  

Along with not being able to distribute any losses, a trust also can’t distribute franking credits, if the trust receives them. 

If the trust contains Australian equities that issue franking credits, it may be worth considering a Family Trust Election (“FTE”). 

Family Trust Election  

This election for a trust that sets boundaries on who can be in the trust in exchange for concessions. The family group may include spouses, parents, grandparents, siblings, children or nephews/nieces and the spouse(s) of all mentioned. 

This election is primarily used to take advantage of benefits not available to a discretionary trust without it. These benefits are primarily ones that a discretionary trust cannot distribute franking credits and losses. 

If any of the conditions of an FTE are violated, the trust may be liable for family trust distributions tax. It is always prudent to have a tax professional heavily involved in the management of a trust. There’s more information around FTE on the ATO website. 

Costs 

The costs of running a trust vary. As trusts must be maintained, you will pay for the services of a lawyer during initial set-up and any amendments to the trust in the future. You would also pay a tax agent for the annual filing and any maintenance. 

Trust Set-up - The general cost to set up a trust is between $300 and $2,000. 

Maintenace - Annual average around $1,000 to $2,500. 

There are a few reasons why a trust might not be right for you: 

• Your only source of income is employment income. Also applies if your income from investments is minimal and is not enough to justify the flat fees to set up and maintain a trust. 

• You are a sole income household and have no beneficiaries to split with. 

• You have children under 18 who have a high tax rate for trust income. 

• You don’t want the burden of yearly administration, and you want to keep a simple tax structure. 

A trust might be worth considering for those who: 

• Having a high marginal tax rate will maintain a high marginal tax rate for the foreseeable future and generate considerable passive income that will justify the costs of the trust. 

• Have children over the age of 18 that have little to no income.  

• Have retired parents that are on low marginal tax rates and can receive extra income at this lower rate.  

• You have a non-working spouse, or they are on a lower marginal tax rate. 

Types of Income that can be Distributed: 

Employment Income – No 

Investment Income – Yes 

Profits from Business – Yes 

If you are paying tax, it means that you are earning income. Tax is part and parcel of being a successful investor. Trusts may help investors derive considerable passive income from their investments. For others, it may be worth keeping to a simple structure and paying tax at their individual tax rate. 

Ensure that if you are considering a family trust, you consider the implications in collaboration with a tax agent or financial adviser.