Running a thriving business is every family business owner's dream. But as your business grows, so do your tax obligations.
A family trust can be a suitable option for business owners looking to take advantage of tax-effective planning.
Liston Newton Advisory provides advice and guidance for business owners looking to set their businesses up for success. Read more about the taxation advice we can offer.
What is a family trust?
As the name suggests, a family trust is a type of trust fund set up to conduct a family business or hold your family's assets.
What are the tax benefits of a trust?
There are several family trust tax advantages, which can be a solid tax minimisation strategy. That's why it’s vital to know whether you’re eligible to create one.
Protect company assets
A key family trust tax benefit is that the fund owns all assets it gets assigned. If you then nominate a company as the trustee, this effectively shields those assets from liability and works to protect your family's assets.
Protect family investments
Another significant tax benefit of a family trust is that the trust can act as a holding structure for your family investments, protecting them from legal or financial liability.
Create a family income
If you run a growing family business, a family trust can be a robust way to look after your family and secure your assets. You can assign your family members as beneficiaries of your business, allowing them to receive income and/or taxable profits directly from the trust.
Protect your children’s inheritance
While Australia does not levy an inheritance tax, a family trust can protect the capital it holds from capital gains and income taxes. This will allow you to distribute a greater amount of your wealth to your children.
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There are two common types of family trust structures. This article focuses on the discretionary trust structure.
This is the most flexible type of family trust structure, and it operates strictly within a single family group. It's also known as a discretionary trust, as the beneficiaries don't claim a fixed income. Instead, you're able to set different income percentages for different beneficiaries, and these amounts can change from year to year. Ultimately, it is the discretion of the trustee/s to distribute to the relevant family members within their family group after proper tax planning from their tax advisers/accountants.
The tax benefit of discretionary trusts is that the trust does not pay taxes; rather, the trust fund money received by the beneficiaries is taxed at each beneficiary’s individually calculated (and usually lower) tax rate.
Please see below an example of a family trust structure with a corporate trustee:
Also known as a fixed trust, a unit trust operates slightly differently from a discretionary trust. Within this structure, the profits are divided depending on the fixed ownership percentages stipulated in the unit trust agreement when the entity is set up. A unit trust allows for more than one family group to be involved in the fund.
Please see below an example of a unit trust structure with a corporate trustee:
Tax rates for a family trust
A family trust typically pays zero tax on income from within the trust. Instead, the income is distributed to the beneficiaries, who are taxed at their personal tax rates. The trustee of the fund decides who within the family receives the distributions. They are free to distribute the income to as many beneficiaries as they see fit. However, you must always check your trust deed to ensure that certain beneficiaries are included within its guidelines.
Making the correct calculations when distributing the income proportions will enable the family to take advantage of each beneficiaries' personal tax rates. The only instance in which a family trust does pay tax is if the income isn't distributed to its beneficiaries. In this case, the trust gets taxed at the highest marginal tax rate (47%).
The family trust capital gains tax
Australian family trusts do pay capital gains tax (CGT). Fortunately, family trusts benefit from a 50% CGT discount.
For example, if you were to sell your business or its assets, you would trigger a CGT event in which a tax would be levied upon the profits of your sale. If you operate as a company, you will need to pay CGT on the entire sum of your capital gains. But if you operate as a family trust, you will only be taxed on 50% of your capital gains income.
Example of family trust tax benefits
A sole trader earns $200k profit from their business, and therefore they receive all the income themselves. This results in an estimated $65k in tax payable to the business owner.
But say the same business operates as a family trust, using the example of a mum and dad business with an adult child working in the business. The business owner/s can now split their income among their family members instead of it being taxed in one person's name. If split equally, each family member would receive approximately $66.6k each. As each family member is taxed at their individual tax rates on this distribution, the combined tax payable would reduce to approximately $40k in total. This is a tax saving of $27k every year.
Can family trust funds be taxed?
In Australian family trust structures, taxes are usually levied upon the trust's beneficiaries. In certain instances, however, the government can impose a tax on the trustee or the family trust itself.
The non-resident beneficiary tax
The trustee is liable to pay the taxes of any beneficiary who is not an Australian resident for tax purposes.
The minor beneficiary tax
While minors can be listed as family trust beneficiaries, this tax discourages the practice. Beneficiaries under 18 can receive a maximum of $1,308 from the trust; any gain higher than that is taxed at the top marginal rate of 45%.
The undistributed trust income tax
All income in the family trust must be distributed to the nominated beneficiaries. If it is not, the trustee will be liable to pay a tax on the remaining income at the top marginal tax rate of 45%.
The family trust distribution tax
A family trust distribution tax is placed on any individual outside the trust’s listed beneficiaries.
Family trusts are set up to distribute capital to a nominated list of family members. Suppose the trustee chooses to distribute money to a party not included among the trust’s beneficiaries. In that case, the trustee will have to pay a tax on the value of that distribution. This is called the family trust distribution tax.
The family trust distribution tax rate is set at the top personal marginal tax rate, plus the Medicare levy. At the time of writing, the family trust distribution tax rate can amount to 47%.
Set up costs for a family trust
When setting up a family trust, you can expect to pay between $1,500 and $2,500 + GST.
- Creation of the trust deed.
- Advice on who should be nominated as the trustee, appointor, and settlor.
- Advice on who the beneficiaries should be.
- Registration of its tax file number with the ATO.
- Registration of an ABN and GST (if needed).
- Collating of a bank account kit which allows you to simply have a new account setup for this entity upon its successful creation.
As outlined by the ATO, franked distributions can be included in the family trust's net income and distributed to its beneficiaries for tax purposes.
However, unlike regular business income, the allocations for these amounts must be formally detailed in the trust deed. The trust deed can also prevent beneficiaries from receiving franked distributions.
Where no beneficiary is appointed, the franked distribution is taxed proportionately between the beneficiaries based on their usual entitlement to the trust's income.
If the beneficiary qualifies for a franking credit offset, they're required to include this amount in their assessable income.
Do family trusts pay land tax?
Land held within fixed, discretionary or unit family trusts is subject to surcharge rates. The trustees are liable to pay these rates.
Each Australian state has its own laws regarding family trust land tax. They can be a challenge to navigate, but your Liston Newton advisor can help you untangle them.
Does a family trust file a tax return?
Trustees are required to lodge income tax returns for their family trusts, and are charged separately from their individual or corporate taxes.
The final word
Running a growing family business is exciting. However, without proper tax planning, you could lose up to 49% of your business profits in tax. If you're considering an effective way to minimise the tax payable on your business' income, then a family trust might be right for your situation.
You also receive a level of comfort that your family's assets are secure, and you're creating a long-term structure that can set your family up for a comfortable future.