Thankfully there have been no real changes to trusts recently, so there is nothing “exciting” to note – but there is one very important task that needs to be done by all trusts before 30 June.
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.
TRUST DISTRIBUTION STATEMENTS
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 2021 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.
We are leaving it up to you whether you comply with this requirement. If you choose to, simply forward us a copy and we will ensure we distribute your trust income in accordance with your wishes. If you choose not to, we will do what we always have.
For those wanting to do the right thing, below are links to a couple of templates that may assist:
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 2021 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 2021 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 had this money taxed at 39% instead of 47%.
In which case some thing 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.