But with increased attention from the ATO, and rules becoming more intricate, the use of these trusts is now under a sharper spotlight. For those hoping to benefit, understanding how they work, and where the traps lie, is more important than ever.
How Family Trusts Offer Flexibility in Tax Planning
A family trust, most commonly structured as a discretionary trust, allows a trustee to manage assets and decide how income and capital are distributed each year. This discretion is what makes them attractive from a tax point of view. Rather than income being locked into fixed percentages, trustees can allocate earnings based on each beneficiary’s financial situation.
According to H&R Block Australia, one of the clearest tax benefits is the ability to direct income towards beneficiaries on lower tax brackets. For example, if one family member is a student with minimal income, the trust can allocate a portion of profits to them, potentially avoiding high marginal tax rates. The idea is to reduce the total tax paid across the family group.
That said, rules are strict. The ATO requires that all distributions be finalised in writing by 30 June each year. If this is not done, the income may be taxed at the top marginal rate of 47%, regardless of the beneficiaries’ circumstances. For children under 18, the rules are even harsher. Under Division 6AA, unearned income above $416 is taxed at rates of up to 66%, limiting the trust’s ability to split income with minors.
Trusts can also stream certain income types, like capital gains and franked dividends, to beneficiaries who can best take advantage of tax offsets. For instance, capital gains can be directed to someone with past losses, minimising tax, or to an individual who qualifies for the 50% Capital Gains Tax discount. However, this only applies if the asset was held for more than 12 months and the gain is distributed to an individual, not a company.
Complexities and Risks behind the Rising Use
Despite their advantages, family trusts involve significant administrative and compliance burdens. A formal trust deed must be drawn up and respected at all times. Each year, trustees must not only determine how to allocate income but also lodge a trust tax return and ensure that each beneficiary reports their share accurately.
The increasing use of corporate beneficiaries, often called “bucket companies,” adds another layer of complexity. These companies receive trust income taxed at a lower corporate rate (25% for base-rate entities), but issues can arise if the money isn’t physically paid. Under Division 7A, unpaid trust distributions to companies may be treated as loans and attract further tax as deemed dividends.
Losses are also tightly regulated. Trusts cannot pass losses on to beneficiaries. Instead, any revenue loss must be carried forward within the trust. To use those losses, the trust must pass certain continuity and control tests, or risk forfeiting them altogether.
According to the ATO, many trustees fail to meet compliance requirements, leading to audits and unexpected tax bills. With increasingly sophisticated data-matching systems, the tax office is paying closer attention to arrangements that appear artificial or primarily tax-driven. In light of these pressures, experts urge caution. While family trusts can offer genuine tax planning advantages, they require ongoing professional advice and meticulous record-keeping to avoid serious financial consequences.
