Legal Tip 235: Should Your Spouse’s New Spouse Be Excluded from a Trust you set up?

When setting up a discretionary trust generally people want to set it up in such a way the class of beneficiaries is wide. Often the deed is worded in such a way that the spouses of beneficiaries are also beneficiaries of the trust.


The wording of the trust deed might be something like this:

Primary Beneficiaries
a) Marge
b) Homer

Secondary Beneficiaries:
Any children, grandchildren, parents, grandparents, siblings, cousins or spouses of the primary beneficiaries.


This wording will mean that if Homer dies and Marge remarries or enters into a de facto relationship that new spouse will be a beneficiary of that trust. It might even mean that if Marge is having an affair with someone (such as with Ned), this would be enough to make that person a beneficiary. This is because they could fall into the definition of ‘spouse’.


There are both positives and negatives to excluding or not excluding new spouses.

Example 1
Homer has set up the Studly Trust. Homer and Marge are listed as the primary beneficiaries and secondary beneficiaries are people related to the primary beneficiaries and includes ‘spouses’ of these beneficiaries. ‘Spouse’ is defined as married or defacto.

For a few years income of the trust is distributed to both Homer and Marge. All is going well.

Then Homer starts having an affair with the milkman. This continues for a number of years.

Marge dies – from milk poisoning possibly.

Homer realises that the milkman meets the definition of ‘spouse’ so starts paying him income from the trust. He does this to save tax.

At the same time Homer enters into a new relationship with Manjula Nahasapeemapetilon, the former wife of the Kwik-E-mart owner Abu. She is not working so he causes the trust to pay her $30,000 per year – for tax reasons.

Meanwhile the family who were meant to be benefitting from the trust when it was set up by Marge and Homer 10 years ago are missing out.

Not fair from Marge’s viewpoint as the assets she helped build up are benefitting people outside of her family, and at the expense of her children.


But it could be beneficial in some situations.


Example 2
Marge and Homer divorce. Homer takes control of the trust, with Marge’s agreement. Homer is the only primary beneficiary named, but Marge still would fall into the class of beneficiaries by her being the mother of the children of Homer as they are beneficiaries.

Homer needs to pay Marge some money each year to help her take care of the children. Homer could pay tax on his salary and give her that way, or he might cause the trust to distribute money to Marge and let her pay the tax on it – possibly at a lower rate.


Example 3
Poor old Marge dies (again) and Homer enters into a relationship with a super hot lady who has a carried forward capital loss. Homer causes the trust to realise a capital gain which is distributed to the hottie who then pays no tax because of the carried forward loss. The money is used by the family – Homer would have been paying out money to support his hot spouse anyway so the family as a whole benefits.


Get some legal advice on this when setting up your trust.

 

In all these cases though everything is still controlled by the trustee? Its not like a spouse can force the trustee to make a distribution to them even if they are part of the beneficiary class.

So more an issue about appointor and trustee.

 

I guess it boils down to do you want your husband/wife benefitting his/her new boyfriend/girlfriend with 'your' money and possible at your children's expense.

 

See also
Legal Tip 254: Should your spouse’s children with someone else be excluded from trusts?

 

A family trust election may itself exclude certain persons from being a beneficiary under tax law (despite what the deed may allow). This generally imposes additional tax and denies other benefits this is not efficient and adds extra cost.

Remarriage etc may then prevent the new family from being tax beneficiaries even if the deed permits it. The surviving spouse may even seek to have the deed amended to add new classes of beneficiaries in accordance with the rules in the original deed. However despite this it may be restricted by tax law. eg Franking credits and losses may be lost or additional tax payable on the distributions. It may also impose a limit on the surviving spouse injecting further funds into the trust if they have a new spouse.

The income injection test and its limitations is well explained in this link and an example family tree.
Family trusts - concessions

If the spouse of the deceased specified individual or a member of their family becomes the spouse of a person who is not a member of the deceased specified individual’s family, the spouse will cease to be a member of the family. Instead, the former spouse of the deceased specified individual or a member of their family becomes a member of the deceased specified individual’s family group. This means that the former spouse of the deceased specified individual won't have concessionary treatment under the income injection test.​

 

Family trust elections don't restrict beneficiaries, just who will receive concessional tax benefits

 

This is super hilarious

 

Yes but the tax issues can outweigh the beneficiary benefit. eg Loss of franking credits may add a substantial cost as may loss of losses. As I said - this is not efficient and adds extra cost. It can a lot of extra cost.

eg Franking adds a extra 42.85% cost. Use of losses may add tax at marginal tax rates.

The benefit of a trust for tax purposes needs legal (tax) advice following death, divorce etc to ensure that tax benefits are not eroded or lost.

 

I don't suggest it would be wise to distribute outside the family group. But it is possible because the beneficiaries of a trust are not changed by a family trust election.