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Are you thinking about running your business through a family trust? Discretionary trusts—commonly referred to as family trusts—are used to run businesses or to accumulate assets for the benefit of the family.A business which operates through the family trusts model has the option to claim tax concessions. In this article, we set out how a family trust pays tax and how this may benefit you.
The Family Trust
A family trust is where a person or company agrees to hold an asset or assets on trust for the benefit of others—usually their family. As such, the trustee is the legal owner of the assets while generally the beneficiaries only have a right to potentially receive distributed of assets.
Whether the trustee is an individual or corporate trustee (company) does not affect the process of taxing a family trust.
Taxation of Trusts
At the basic level, the trust itself does not have to pay tax. Instead, the trustee lodges a tax return each year to report the net income or loss of the trust. For example, the calculation of net income involves taking the total income (business and investments) earned by the trust and subtracting the costs of doing business.
Firstly, it is important to understanding who is entitled to the family trust’s distributions. Generally, net losses are trapped in the trust and cannot be distributed to beneficiaries. Otherwise, the beneficiary will pay the trust’s tax, unless:
- the beneficiary lacks the entitlement to receive trust income; or
- the beneficiary has a legal disability, such as due to being a minor.
In these cases, the trustee will pay the tax of the trust.
After determining which people are entitled to the trust’s distributions, you can begin the process of tax planning.
1.Calculating Net Income or Loss of a Trust
The trust’s net income includes the total assessable income of the trust after deductions. The total assessable income will also consist of capital gains made by the trust.
For example, if you run your business through a trust, the net income of your trust may include:
- any profit made that financial year while operating your small business; and
- any gain made from selling a capital asset, such as a house.
2. Beneficiaries Presently Entitled to Trust Income
A beneficiary of a family trust is generally entitled to be considered to receive the trust’s distributed income. The beneficiary must be presently entitled, meaning they have a legal right to demand and receive the income. Generally, a beneficiary will be presently entitled they have a claim or interest in the income that cannot be beaten by another person’s claim.
When you engage in tax planning, it is crucial to account for the family trust’s net income when calculating the beneficiary’s or trustee’s assessable income. Otherwise, this income becomes taxed in the hands of the trustee at the top marginal individual tax rate.
3. Does Legal Disability Apply?
If one of the beneficiaries is a minor (under 18 years) and is distributed income, the trustee must pay the top marginal individual tax rate. The tax-free threshold for minors is $0 to $416. As an exception, minors in full-time employment pay the ordinary adult tax rate.
4. Beneficiary Pays Tax
Finally, after a beneficiary receives net income from a family trust, the beneficiary pays income tax at their marginal tax rate. This means they can add it to their other forms of income, including employment income, and pay their tax.
However, if the family trust made a loss in an income year, then income cannot become distributed to the beneficiary. However, the loss may be counted forward and used to lower the trust’s net income in future.
Capital Gains Tax Events for Trusts
Businesses must report capital gains and losses in their income tax returns, but these only arise where Capital Gains Tax (CGT) events occur. There are nine CGT events relating to trusts, and the common ones include:
- the creation of a trust over a CGT asset;
- the transfer of a CGT asset to the trust; and
- the beneficiary becoming entitled to a trust asset.
The trust will make a capital gain or loss if a CGT event happens, which will trigger your CGT obligations. For example, if you make a profit from selling off a capital gains asset, you will generally include the profit in your assessable income.
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