How to Use a Family Trust for Tax Savings in Australia

A family discretionary trust is a legal structure where a trustee holds assets and income for the benefit of a class of beneficiaries. The trustee has full discretion each year to decide who receives income - making it the most flexible tax-planning vehicle available to Australian families.

• The key parties: settlor (establishes the trust with a nominal gift), trustee (controls the trust - individual or company), appointor (power to remove/replace the trustee - the most powerful role), and beneficiaries (defined class in the trust deed)
• Trustees are most commonly a corporate trustee (Pty Ltd) - this provides asset protection, continuity, and avoids land tax surcharges that apply to individual trustees in some states
• Annual trust income is distributed to beneficiaries by 30 June each year via a trustee resolution - undistributed income is taxed at the top marginal rate of 47% (as trustee tax)
• Family trusts hold assets (shares, property, business interests) that generate income - the trust itself does not pay tax on income distributed to beneficiaries
• A family trust election (FTE) can be made with the ATO to access trust loss provisions - this restricts the trust's beneficiary class to a defined 'family group' but allows losses to be streamed
• Setup costs: trust deed preparation ($500-$1,500), corporate trustee ASIC registration and company setup ($600-$1,200 via ASIC + accountant fees), plus annual ASIC fees ($59/year for small proprietary company)

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Distributing trust income to lower-income family members - instead of concentrating it in the hands of the highest earner - reduces the total tax paid by the family unit. This is the primary reason high-income families use trusts.

• Example: a family trust earns $200,000 in net income. The trustee distributes $18,200 to each of a spouse (no other income) and two adult children (students with no other income) = $54,600 at 0% tax; remaining $145,400 distributed to the high-income spouse at 47% = $68,338 tax. Total tax: $68,338
• Without a trust: $200,000 income taxed entirely at the top rate = approximately $73,027 in tax - saving of ~$4,689 just from splitting to spouse and two adult students
• With 4 beneficiaries each utilising the $18,200 tax-free threshold: $72,800 at 0% tax, $127,200 remaining distributed to highest earner - significant reduction in family tax
• Minor children (under 18): trust distributions to minors are taxed at penalty rates under Division 6AA - $416 tax-free, then 66% tax from $417 to $1,307, then 47% above $1,307. Minor beneficiaries provide almost no income splitting benefit
• Adult children over 18 in full-time education: assessable for tax at normal adult marginal rates - $18,200 tax-free threshold applies. A distribution of $18,200/year costs zero tax and saves the high-income family member ~$8,554 (at 47% rate)
• Spouse with low income: distributions to a working spouse earning $60,000 - additional trust income of $40,000 is taxed at 32% (after LITO phase-out effects) rather than 47% at the primary earner's rate, saving approximately $6,000

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Section 100A of the ITAA 1936 allows the ATO to void a trust distribution where a beneficiary is made presently entitled to income but the economic benefit goes to someone else - particularly where there is a 'reimbursement arrangement' in place.

• Section 100A applies where: (1) a beneficiary is made presently entitled to trust income, (2) there is a reimbursement arrangement under which the benefit is provided to another person, and (3) the arrangement was not entered into in the ordinary course of family or commercial dealings
• Common s100A risk scenario: trust distributes $80,000 to an adult child, but the adult child never actually receives the cash - instead the money flows to the parents' mortgage or back into the trust as an unpaid present entitlement (UPE)
• The ATO released PCG 2022/2 (Practical Compliance Guideline) establishing a risk framework: low-risk (green zone), medium-risk (amber zone), and high-risk (red zone) arrangements - advisers should review all existing trust distributions against this framework
• Green zone (low risk): distributions to adult children who are active in the family business, distributions at commercial arm's length, where cash is actually paid to beneficiaries
• Red zone (high risk): circular flows where distributed amounts return to the trustee or appointor; distributions to low-income beneficiaries where there is a reimbursement agreement; patterns inconsistent with genuine family dealings
• If the ATO applies s100A: the distribution is treated as if it was never made - the trustee becomes assessed on the income at 47% (top rate), plus penalties and interest. This is a catastrophic tax outcome

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When a trust distributes income to a corporate beneficiary but does not actually pay it over, the unpaid present entitlement (UPE) can become a deemed dividend under Division 7A - triggering unexpected taxable income for the trust or its associates.

• UPE arises when a trust resolves to distribute income to a company beneficiary (e.g., a bucket company) but leaves the amount sitting as a loan in the trust's accounts
• From 16 December 2009, a UPE owed to a private company triggers Division 7A unless it is either: (a) placed on a complying Division 7A loan agreement (maximum 7-year term, benchmark interest rate 8.27% for 2024-25), or (b) set aside in a sub-trust for the exclusive benefit of the company
• If a Division 7A loan is not put in place, the UPE is treated as an unfranked deemed dividend in the income year the UPE arose - assessable to the shareholder of the company (often the same high-income individual)
• Corporate bucket company strategy: distributing income to a company beneficiary at 25% or 30% company tax rate can reduce current year tax burden - but extracting money from the company later via salary, dividends, or loans triggers additional tax
• The ATO's 2018 PCG (2018/4) provided safe-harbour sub-trust arrangements that can quarantine UPEs from Division 7A - but these sub-trusts must be properly documented and maintained
• Practical tip: always formalise UPEs as Division 7A loans before the trust's lodgment date - the benchmark interest rate, minimum repayment schedule, and written agreement must all be in place

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Trusts can stream specific categories of income to specific beneficiaries - allowing capital gains to go to beneficiaries who can use the 50% CGT discount, and franked dividends to go to those who benefit most from franking credits.

• Trust streaming rules (Subdivision 207-B ITAA 1997 and Division 6E): allow trustees to specifically allocate capital gains and franked distributions to nominated beneficiaries - the character of the income flows through to the beneficiary
• Capital gain streaming: distribute a capital gain (with 50% CGT discount applied) to a beneficiary who has capital losses to offset, or who is in a low marginal rate bracket - the beneficiary uses the discount and their own tax position to minimise the CGT outcome
• Franked dividend streaming: direct franked distributions to beneficiaries who pay the most tax - the franking credits reduce their tax bill by the most (or can be refunded if their marginal rate is below 30%)
• Retirees with low taxable income: receiving a streamed franked distribution with a franking credit can generate a cash tax refund - the franking credit offsets nil or low tax, with the balance refunded by the ATO
• Streaming must be done correctly: the trustee resolution must identify the specific capital gain or franked distribution being streamed, name the beneficiary, and be recorded before 30 June - verbal or retrospective resolutions risk ATO challenge
• Non-streaming default: if the trustee does not exercise streaming, capital gains and franked credits are proportionally allocated across all beneficiaries based on their share of total trust income - often a worse outcome than deliberate streaming

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Family trusts are powerful but not universally appropriate. The annual compliance cost and structural complexity mean they only make financial sense in certain situations.

• Strong case for a trust: combined family income above $200,000 with multiple potential beneficiaries, business income that fluctuates year to year, intention to hold investment assets (shares, property) long-term, or estate planning complexity (blended families, asset protection needs)
• Annual compliance cost: accounting and tax return preparation typically $2,000-$5,000/year for a simple trust - the income splitting benefit must exceed this cost to justify the structure
• Land tax implications: in NSW, Victoria, and Queensland, trusts do not receive the land tax-free threshold that applies to individuals - this can significantly increase annual holding costs for residential investment properties in trusts
• Negative gearing inside a trust: trust losses cannot be distributed to beneficiaries - a negatively geared property inside a trust produces a loss that is trapped in the trust until the trust generates positive income in a future year
• Stamp duty on transferring property into a trust: in most states, transferring an existing property into a trust triggers stamp duty - trusts work best when assets are acquired directly into the trust structure from the start
• Family breakdown risk: if relationships between family members deteriorate, the trustee has discretion to exclude certain beneficiaries from distributions - careful drafting of the trust deed's beneficiary class and appointor provisions is essential

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