A family trust can be an excellent way for parents and small business owners to protect their children's financial futures. But they are not a surefire safeguard. So, should you set up a family trust? That’s the question we’re here to answer.
There are several advantages and disadvantages of family trusts that you must carefully weigh. But, if correctly set up and diligently managed, a family trust can be a significant advantage — especially come tax time.
The Liston Newton Advisory team are experts at providing support for those looking into setting up a family trust in Australia.
What is a family trust account?
A family trust is a discretionary fund that holds valuable family assets and distributes income to its beneficiaries.
In Australia, family trusts are established by trustees: in this instance, parents. The trustees can fill their family trust with profit from their family business, and the trust will then distribute that income to its beneficiaries: the children, grandchildren and their spouses. The trustees determine the value of the distribution each beneficiary receives.
How a family trust works
A family trust works by reducing your business’s tax obligation to the ATO.
Much like a company structure, a family trust prepares a set of annual financials and lodges a regular trust tax return.
- Profit is calculated at the end of the financial year (income, minus expenses plus the previous year’s losses), and then distributed to the beneficiaries.
- Distributions received from a trust form part of the beneficiary's assessable income. If the beneficiary receives income from other sources, too, all their income is taxed together.
The trust doesn’t pay tax, so beneficiaries are taxed on the amount of income placed in their name. If the business being run via the trust generates more than $75,000 of income in a financial year, then the trust is required to register for GST.
An example of why you should set up a family trust
If you operated as a sole trader and earned $200,000 in a year, you would be obligated to pay approximately $65,000 in tax.
Instead, you could have your profits placed within a family trust to lower your tax obligation. Then, you can have the trust distribute a portion of the profits to you and the other beneficiaries.
Except in certain specific circumstances, the trust does not pay tax. Rather, the beneficiaries are taxed at their personal tax rates, which are likely lower than the corporate tax rate you would have otherwise paid.
In this example, if each beneficiary receives $66,600 from the trust, the combined total tax owed would be around $40,000.
In the end, your family trust has saved you $27,000.
Why establish a family trust?
The primary purpose of a family trust account is to protect your income by reducing your tax obligations.
There are three key reasons why you should set up a family trust:
- Your family business is growing
- You have new business opportunities
- You need to structure your investments properly
When should you set up a family trust?
The best time to set up a family trust is if you run a family business and:
- Profits are growing
- The business is expanding
- Your average tax rate is approaching 30%
In these instances, a family trust can help reduce your tax rate. A family trust can also act as a holding structure if you're making significant investments. It can protect those assets from financial and legal troubles and save you tax along the way. However, entering into a family trust isn’t a simple decision. It requires careful thinking and planning for the future of your business and investments.
Let’s look at the pros and cons of a family trust in detail.
Family trust advantages and disadvantages
Advantages of having a family trust
Family trusts make your business tax-effective
Income and capital gains can be distributed across a family group in proportions that best suit each individual's tax rates. This means setting up a family trust allows a trustee to distribute profit from a business in a tax-effective manner.
When the profit of a business gets too large to distribute effectively, a family trust can also distribute to a separate company to cap the tax rate at 30 per cent.
Family trusts make your investments tax effective
A family trust is a tax-effective structure to hold investments, as the dividend income received can be distributed across the family in a way that best minimises tax. If an asset is sold after 12 months, the trust can receive a capital gains concession, and the capital gain income can be distributed among family members.
Family trusts protect your business assets
If you run a business from a family trust, you can set up a company to act as the trustee. This means you can access the limited liability advantages of a company structure, and gain the tax flexibility advantages of a family trust.
Family trusts protect your investment assets
A family trust can protect the assets of a family group, as assets aren’t held in your personal name. A family trust is a separate legal entity, meaning you can access a certain level of protection if you face financial difficulty or legal action.
Disadvantages of family trusts
Family trusts only distribute to your lineal family
One of the main disadvantages to a family trust is that you can’t add people outside your family, and you can’t add additional shareholders. Therefore, if you plan to run your business from a family trust and desire to grow your business beyond your family in the future, then a family trust may be a significant disadvantage.
Family trusts do not scale well
If your business truly takes off and profits begin to exceed $500,000 per annum, the tax planning of a family trust becomes increasingly difficult. In this case, a company becomes a better solution.
Family trusts cannot access government grants
A family trust can flexibly access funds, though it’s quite limited in other ways. Operating a family trust means you likely can't access many government grants and tax concessions, such as the Research and Development tax concession, or Early Stage Investor Concessions.
Family trusts require ongoing maintenance
A family trust requires ongoing accounting and tax advice throughout its life. These costs start at $1,500, plus GST, for very simple holding trusts. The amount increases as the trust becomes more complex.
Book a free financial strategy session
A 90-minute strategy session gives you a clear plan for your family trust.
- Get a better understanding of your needs
- We generate a detailed report from your strategy session
- Understand your priorities and next steps
Set up costs
In Australia, the cost of establishing a family trust is relatively low. A trust generally costs $1,500 (plus GST) in legal documentation to set up, or $2,500 (plus GST) for a trust with a corporate trustee.
Should you have a family trust? The big question answered.
While the family trust tax and asset protection benefits are obvious, it’s a structure that needs to be adequately understood before you enter into one.
To decide if you should create a trust for your family business, ask yourself the following questions:
- Am I expecting more people to join my business?
- Am I expecting anyone to exit the business?
- Do I intend to sell my business for a significant capital gain, or do I want to issue shares to existing employees?
- Do my family or I plan to take advantage of government grants or tax concessions?
- Am I prepared to keep strict financial records?
A family trust might be right for you if you need a tax-effective plan to protect your family and business assets.
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If you’re looking for a structure that provides for tax-effective planning, and an improved level of protection for your family and business assets, then a family trust might be for you.