Trusts are largely unchanged, but the ATO has indicated that they will be looking to ensure that the people actually receiving the money from a trust are the people paying tax on that money – discussed in more detail below.
For more general commentary and tips, have a read of:
- Our EOY article on changes and tips for businesses (regardless of what structure that business is in);
- Our EOY article on changes and tips for individuals; and
- Our EOY Tax Tips brochure.
THINGS TO DO BEFORE 30 JUNE
There is only one thing that trusts need to do before 30 June:
- Decide on how the trust’s 2023 income will be distributed (split) and record this decision in a minute or resolution – see below for more detail.
Warning On Splitting Distributions With Children
The ATO have publicly stated that they will be targeting trusts where the distributions on tax returns is different to where the money goes – this is the situation where Mum & Dad will use a trust to have some of their income taxed in other people’s tax returns (such as children), but don’t actually give them the money.
Why would Mum & Dad do this? To lower their tax. If Mum & Dad are on a higher income, they can minimise their tax by having some of it taxed in, say, an adult child that is studying full time and not working much.
The ATO has the position that “the person using the money is the person that pays tax on the money”, and will be looking to enforce this. If you have a trust and distribute some of that income to children (or other people) to minimise tax, then you should have a discussion with your accountant.
TRUST DISTRIBUTIONS
By Law, every trust must make a decision by 30 June how it will distribute its income for the current financial year (i.e. you need to decide within the next few weeks how your 2023 income will be split). Obviously, you don’t know today what the total income of your trust will be – which is the dilemma.
Accountants always historically just split the trust income however is most effective when they do your tax returns, but the ATO is showing an increasing desire to enforce this rule. Essentially it means that you need to decide today how we are going to split your yet to be calculated trust income.
Crazy, we know.
For those wanting to do the right thing, below are links to a couple of templates that may assist (we note these are in the process of being updated, so check in on these later in the month):
What Is A Distribution
It is important to understand that a “distribution” refers to allocating the profit, and not necessarily the physical payment of monies.
When a trust makes a profit, this profit must be “distributed” (i.e. allocated) to one or more people – if it doesn’t then the trust pays tax at the top tax rate. The person distributed (allocated) this money must pay tax on this money now (even if they haven’t physically received the money yet).
If these amounts are unpaid at this point in time (which is likely), then these amounts sit in a loan account that can be drawn upon at a later stage. The drawing of this money (which has already been taxed in the hands of the recipient) comes out tax-free.
Why Must A Trust Distribute
Essentially to avoid paying tax at the top tax rate, the trust must decide to distribute its income to one or more people. As outlined above, these people pay tax on that money in the same year that the trust earned that income.
So, where a trust makes a profit of say $50,000 in the 2023 year, one or more people will end up paying tax on that $50,000 – even if that money remains in the trust’s bank account (or tied up in other assets).
How Do I Do It
Unit trusts are pretty straight forward – the distributions are generally always in line with the percentage each owner holds in the trust so the decision that it needs to make is whether it will distribute its income or not (i.e. decide whether it will pay tax at the penalty tax rate or not).
Discretionary trusts are different in that the amount distributed to each person can change from year to year and you need to actually make a decision on how much each person will be distributed.
When working out how you will split your unknown trust income (remember, we are doing this today and you won’t know what all the trust’s income and expenses are), it is important to know that you don’t need to specify specific amounts, you can use percentages. You can also provide an order to the distribution.
For example, you could say Mrs X will receive the first $10,000, Mr X will receive the next $5,000, Mrs G and Mr G will receive 50% of the balance each.
They key is that you want the people on the lowest tax rates receiving the distribution, so in an example where:
- The ABC Family Trust is expected to make a $50,000 profit for the 2023 year;
- Mr A has personal income of $120,000;
- Mrs B has personal income of $200,000; and
- Mr C has personal income of $10,000…
The potential tax outcomes vary as follows:
- Any amounts Mr A is distributed will be taxed at 39% (a potential total of $19,500).
- Any amounts Mrs B receives will be taxed at 47% (a potential total of $23,500).
- Mr C on the other hand will pay a total of (approximately) $11,000 should he be distributed that full amount.
In this case, you may simply say that Mr C should receive 100% of the distribution. Nice and easy – right?
You also need to consider what happens if you estimate the trust’s income incorrectly and instead of $50,000, it’s $300,000 (maybe you didn’t realise that the cryptocurrency you cashed in is a taxable sale, or possibly you mistakenly thought that the house you sold that settled next year is taxable next year).
If you distribute 100% to Mr C, then they will pay tax on the full $300,000 whereas it would have been more prudent for Mr A to have received $60,000 and have this money taxed at 39% instead of 47%.
In which case something like “the first $170,000 to Mr C, the next $60,000 to Mr A, and the balance split evenly between Mr A, Mrs B, and Mr C (because at this point they are all paying the same tax rate).
As you can see trust distributions are complicated, and it is important to get good advice. However, almost anything is better than the trust paying tax at the top penalty tax rate of 47% – so please ensure you have a trust distribution documents date 30 June or earlier on file.
