Tax Tip 320: Trusts Pay No Tax? What!

Discussion in 'Accounting & Tax' started by Terry_w, 14th Dec, 2020.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I am often asked what the tax rate for trusts is. It is generally nil as the trust, although a tax entity, will not retain any income on which it is taxed.

    The income of a trust will, generally, flow out to beneficiaries who are then taxed on that income on top of their other income. This is usually the case with discretionary trusts and unit trusts.

    Example

    Homer has set up the Simpson Family Trust. The trust generates $10,000 from an investment.

    Homer, as trustee, resolves to distribute that income to Marge who is a beneficiary of the trust.

    The trust will not have any income on which it is taxed.

    Marge will be taxed on the income of $10,000 which is added to her other income for the year.

    If Marge had no other income, she would pay no tax.

    But if Marge had earned say $200,000 from her work then she might end up paying $4,700 tax on this $10,000 from the trust.


    But. Sometimes trusts can retain income. When this happens, the trustee is taxed on the income at the top marginal tax rate.


    Example 2

    Since both Homer and Marge are already on the top marginal tax rate Homer might leave the income in the trust and not have any beneficiary become presently entitled to it and have ‘the trust’ pay the tax.

    Leaving the income in the trust in a situation like this might be done for asset protection reasons or for estate planning – or perhaps simply because Homer forgot to make resolutions in time (before 30 June at the end of the financial year).
     
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  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Importantly if a trustee fails to distribute the net income of the trust on 30 June or prior (subject to the terms of the deed) any tax is assessed to the trustee at the top marginal tax rate of 45%. This can also occur if the ATO amends the trust tax return to include additional income or if a defect in the resolution occurs. A fixed trust may not have any requirement to make a valid resolution if the beneficial interest is an absolute entitlement (eg a unitholder may have a fixed share of unit trust income). For very high income beneficiaries it can be a strategy to deliberately allow the trustee to pay tax rather than the individual who may be subject to more Medicare, higher HELP repayments (esp medical specialists) and Div 293 tax etc.

    A non-resident beneficiary may be different. s99 / s99A may assess tax on this income at non-resident rates. The trustee will be assessed. And to make it all the more confusing when that occurs the beneficiary may need to wait to lodge a personal return until after this trustee tax is paid. Then it can be creditable. And then to further make it confusing some net income of the trust is exempt when paid to a non-resident. Examples of this include CGT amounts that are NOT taxable Australian property. eg Bank shares or exempt income such as a share of franked income.

    A child beneficiary may be subject to trustee tax with some adjustment for testamentary income

    Taxation of trusts is a complex issue and is usually best addressed by a competent tax adviser that is experienced with trust taxation laws and practices.
     
  3. Trainee

    Trainee Well-Known Member

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    If a testamentary trust fully distributes for tax purposes but does not distribute in cash (i.e. as a UPE), does the income on the retained cash also have s102AG nature?
     
  4. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I'm confused as to the duplicated use of the word "income" and its alternative with "cash". But addressing a UPE its wise for the trust to discharge its beneficary entitlements prior to the required date/s and to extinguish any legal liability. There can be some issues too where a parent acts as a trustee for a child and is also a exectutor - trustee for a TT. ie the two hat issue. In wealthier families its essential that testatmentary entitlements given are ...given... to avoid continued liability.

    Ways a family can address that discharge can include school and tertiary education, dental costs, weddings etc. Wise that evidence of this is permanently maintained
     
  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I think there is some confusion re the distirbution thing.
    A trustee does not need to distribute income before the end of the financial year, just make a beneficiary presently entitled.
    The beneficiary would then have an unpaid present entitlement until the amount is paid over.
     
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  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Are you asking if compounding income will be excepted trust income for tax purposes and children could be taxed as adults on it.

    The key here is if the assets of the estate derive from the estate of the deceased, and its earnings.
    I think it would be excepted trust income, but it would depend on the circumstances.
     
  7. Trainee

    Trainee Well-Known Member

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    Yes.

    Assume a testamentary trust has $100k of NAB shares (or some other listed share on the ASX), correctly passed from the deceased estate. Listed shares only, no real estate.

    Dividends of $2,000 is received by the TT on the shares. The minor beneficiary becomes presently entitled to the 2k. UPE recorded of 2k.

    This 2k is used to buy more shares within the TT. Will dividends derived from the additional purchases also be excepted trust income?

    Thinking about a situation where the decreased creates a TT, but the family doesn't need the money from the TT yet. If the above can be done, it would be more effective to build the assets as much as possible within the TT, since in the future (assume 80 years until vesting), it can be distributed to grandchildren, great grandchildren etc.
     
  8. SatayKing

    SatayKing Well-Known Member

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    Similar to the arrangements in place for the TT I managed a one stage.

    One beneficiary was cunning and accessed funds close to the EoFY and used them as a concessional contribution to super - making sure not to exceed the contribution limit.
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    no
     
  10. Trainee

    Trainee Well-Known Member

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    So drps within a tt would be a minefield?
     
  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It could great tricky, but the trust might have other income to distribute
     
  12. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Not really. Assuming franked income the child may receive a full refund of franking credits which is a partial element of a distribution. Generally we see more complex mix of investments in a TT than a specific share. And dont foget AMIT amounts and franked / foreign and CGT discounted amounts can affect what seems like trust income but is not. This can mean net trust income is more / less than actual "income".

    I just completed one such testamentary trust. Each year the income is physically distributed to discharge all UPEs and any legal entitlements. It is done in part prior to 30 June then after June for the balance based on actual amounts.

    One thing many of these trusts have in common is that there can be financial merits to reassess the maintenance of the TT once adult kids are involved. Yes it seems like a tax benefit but then they start to earn income etc and in time there can be logic to winding up (over several years?) some TTs and migrating towards a super efficient strategy. Depends on each family and trust specific issue. Some TTs may not allow winding up for example. I once handled one where there was no (complete) deed and then it took a supreme court decision on what the term of the trust meant. Very costly but allowed the substantial capital to vest and then migration to super for parents and capital for kids to acquire homes.