Legal Tip 93: Bucket Companies as Beneficiaries of Trusts

I too have been reading up about this. My gathering now is only use a bucket if your individual trust beneficiaries end up being distributed over $180k (vs the normal $85k we normally target), as essentially the bucket companies pay 30% tax, so why not just pay out the individual beneficiaries if they're earning under $180k - avoid loan documents and transfers from the bucket company back to any trading entity or project that needs it. Basically if everyone is paying 30% or roughly, just get the beneficiaries to loan back to the trading company/entity that requires the money - risk is if the beneficiaries get sued vs a non-trading bucket company.

In regards to Terry, bucket company ideally should be a separate trust from family trust, otherwise it's just a circle?

 

I think you are talking about average tax rates, but you should consider marginal tax rates.

The marginal tax rate jumps to 32.5% at $37,000 income plus medicare levy. So for every dollar you earn over $37k you will pay at least 34.5% in tax.

Some people can like on $37k each so they divert excess income over this amount to a company - usually those in business.

Beneficiaries should consider lending back or gifting back. I would suggest a discretionary trust may be the better recipient in most cases, rather than a company.

The shares of a bucket company shouldn't be owned by the same trust as it is receiving income from because of s100A ITAA37 which could mean tax at 45%.

 

Sorry I don't understand when you mean can like on $37k?

I'm assuming you mean, some people choose to divert income when individuals receive more than $37k instead of $87k, effectively making their tax rate 10% or thereabouts.

We have trading companies (not in construction) that pay profits to a discretionary trust, then to individual beneficiaries. Normally just pay out via the trust to $37k-$87k then defer the income. The choice of whether to pay individual beneficiaries $37 or $87 I would imagine is pretty subjective. Any excess income now I would think now it would be better to put into a bucket company for equity protection purposes, pay the 30% tax and just get the franking credits later on.

*And yes I am talking about average tax rates. If a bucket company is going to be paying 30%, and at individual rates $180k we pay ~$60000k tax including medi levy this is also 30%. Why not just pay the individuals and lend back to the trading company unless 1. You're making a lot more than $180k per person in the trust can absorb and 2. so equity cash assets can to placed in a bucket company that can't be sued.

 

Depends on so many issues. Div 7A. Unpaid ent itlements. Elections...not as simple as just a tax return

 

what is the tax rate on $37,001? the $1 over $37,000 is taxed at 32.5% plus medicare...

 

Will be paying all entitlements, so no UPE issues, all loans back to trading entities when required will be documented, nothing on accounts base, actual physical transfers.

I believe it is just subjective and a difference of opinion on the $37 or $87 price bracket, some even go the $180k.

Bucket Companies: what you need to know to save $$ in tax - Cinch Accountants & Advisers these guys seem to like $87k lol. However this is only 2 members in a trust. I would gather a lot of trusts may have upwards of 4 or more people.

 

Great summary with nice diagrams. But I don't trust then with the $87k figure as this is where the average tax rate = 30%. But no big deal.

 

The 37/87 really is a difference of opinion, balance of paying personal expenses. Guess two family members 87 k ok but 4 or more couldn't imagine you would need to spend more than 4x37k less taxes on food unless you have a yacht....

 

The tax on 37/80k is a question of fact! Mathematics

But how much you leave in a bucket company will depend on a whole heap of factors, one major one being how much money you need to live on.

 

Do the maths and you will see the difference.

As Terry alluded to, each $ over $37k to $87k is taxed at 0.345 including medicare versus 0.275 staying in the company (assuming turnover less than $50M).

So an extra $50k to individual, is extra tax of $17,250 versus $13,750 at company tax rate. A $3,500 tax saving if left in company until a future income year.

Guess it depends on how little you can live on and how any future tax changes may effect things, aka BSs proposals.

Although at some stage, one may question what is the point of living on $37k a year (or $74k if have wife) and allowing profits to stay in company forever.

 

Another point about these strategies is the extra compounding effect. In this instance imagine having an extra $3500 per year of capital to invest over a period of say 20years.

 

Thanks Willy and Terry you've been a great help. Yes I couldn't visually picture how $3000 could make a difference, but over 20 years it would make a fair bit.

I'm assuming that's why the super rich just pump their money into companies, pay the 30% tax then loan another company the money to buy heaps of properties.

 

The key failing for bucket companies is when someone wants to borrow the company funds or have the company buy a personal use asset like a boat, holiday home etc. For wealthy who have a asset accumulation path due to high income a corporate beneficiary as part of their investment structure can assist to save around 15% (a 1/3rd tax saving) which can assist compounded growth and returns. And part of reason Shorten hates a lower company rate.

Another use of a bucket company can be to establish a compliant loan secured against property so the bucket company is like a family bank.

No better example of this compounding benefit than super. A tax rate on earnings of 0-15% and its a long term growth path. Wealthy also ensure super is part of their strategy too. A SMSF usually for direct property, control and also for the fixed nature of the "fees" ie costs it incurs. A SMSF with $2m may cost a similar amount to run as a $400K fund. SMSF and Trust can also address asset protection, estate planning, death benefit planning and more.

 

A bucket company is like a surrogate SMSF fund really. Main difference being it can transact with related parties and you can get the capital out whenever you choose (with consequences of course).

 

Nice post @Terry_w

The benefit of having a bucket company as a beneficiary to a trust seems all the greater when dividend imputation is taken into account. Assume all the beneficiaries to the trust (apart from the bucket company) are all in the top marginal tax rate but are due to retire in a couple of years. In which case, the trust decides to distribute all money to the bucket company for the first 2 years.

Assume also for the purposes of this example that the trust is producing a $100 of income each year. The bucket company would pay $30 in tax each year on the income, leaving $70. This happens for 2 years ($100 per year x 2 years) so total company income is $200, total tax paid = $60. And the bucket company is left with $140 in cash to eventually pay in fully franked dividends.

At the 2 year point, one of the beneficiaries eventually retires so now has a zero marginal tax rate (or very low, assume 0% for this example to make numbers simpler).

At this 2 year point, the bucket company decides to pay a fully franked dividend of $140. As the shares in the bucket company are owned by a trust (that is my assumption, largely for asset protection purposes), the trust distributes the $140 in dividends to the person on the zero marginal tax rate (this person is a beneficiary of the primary trust and also a beneficiary of the trust that owns the shares in the bucket company).

So, this person gets $140 in cash dividends, so declares franked dividends of $140 and has imputed income of $60 ($140 x CTR/(1-CTR)). Explained another way, under dividend imputation, the income is ‘grossed up’ to be equivalent to the income of the company pre-tax. Ie. $200.

So, taxpayer pays tax on $200 of income = zero (as they are on 0% MTR in this example).

The taxpayer then gets a refund of the franking credits. In this example, franking credits = $60, which Government will refund (note: as we know, ALP’s policy is to ban these refunds of franking credits, which is another story).

All up, beneficiary receives $200 in cash, made up of $140 in cash dividends, and $60 in cash refunds of the franking credits.

In summary, you have managed to pay zero tax on the $200 of income from the original trust ($200 going via the bucket company and held there for 2 years, then going through the trust owning the shares in the bucket company, and eventually to the beneficiary at the point at which they were on zero marginal tax rate).

Without bucket company arrangement, beneficiaries would have paid $100 of tax on $200 of trust income during years they were on top MTRs.

 

In that scenario (locking 100k away for 10 years) why not just invest in an insurance bond?
From what I have read on this forum they are tax free after 10 years. I have wonder though if they do offer any asset protection - this may be of concern to you.

 

This is the general idea. Divert income to a company which holds it, pays tax and then later pays it out to a beneficiary in a different tax year with tax credits.

 

Thanks for the suggestion, but I wouldn't consider one for my own needs due to a lack of flexibility, that is I don't get to control what the bond invests in. They will just invest in an Australian Share fund which is likely to track the market. I like to pick my own stocks.

Secondly it pays tax at the company tax rate on the way through each year, not really much different to setting up your own company.

The only advantage is that at the end of 10 years, you get the lump sum without tax consequences, whereas pulling funds out of a private company is going to have tax consequences marginally offset by the imputation credits and can be well managed if funds drawn out over multiple financial years.

 

If the bucket company is a beneficiary of a family trust (one that has made an FTE) - by virtue of meeting the broad definitions in the trust deed - does it also need an interposed entity election? If it doesn't make the election, is the issue then that family trust distribution tax is payable by the trust on any distribution?

 

Yes