What is a Family Trust?
Savvy investors and business owners are turning towards family trusts as a way to safeguard their investments. Key benefits include asset protection and a means to distribute income to members within the family group. Firstly, setting up a family trust enables the trustee of the trust to manage the tax affairs of the trust. For instance, this could include lodgement of tax returns and payments of any liabilities incurred. Secondly, the individual beneficiaries of the trust may be entitled to receive a trust distribution. This income received from the trust would be required to be reported in the beneficiaries’ tax returns.
What can a Trust be used for?
Setting up a family trust can offer greater flexibility when distributing income to beneficiaries than if you had set your business up as a sole trader. Be mindful of the provision such as personal services income (PSI) to ensure that you are not claiming business deductions where income was earned solely from your personal labour, skills and expertise. A definition with a simple PSI flow chart can be found on the ATO website. In term of uses for the trust, you could set a trust structure up for an e-commerce business, dropshipping, investments or even for a cryptocurrency portfolio. You would need to first make sure that the structure is right for your personal circumstances. Therefore, your accountant and financial advisor can become very useful to ensure that you are making the right decision for your financial future.
There are many benefits to investing through a family trust. I have summarised a list of the pro’s and con’s as follows:
Family Trust Pro’s
- Asset protection (speak to accountant to set up correctly)
- Income distribution
- Succession planning
- Separate investment asset
- Tax planning
- Capital Gains Tax Discount
Family Trust Con’s
- Annual compliance costs
- The high initial cost to set up
- Increased tax reporting in a separate entity
- Increased complexity in financial affairs
- negative tax consequences distributing to a minor
There are pros and cons with any investment decision that requires you to do your due diligence. However, a tailored approach could end up saving you money over the long term. Furthermore, It is recommended that you speak to a qualified accountant for the right advice. Moreover setting up the wrong structure or making errors can have crimpling financial consequences.
Capital Gains Tax Consequences
Capital gain tax (CGT) is a key issue to consider when setting up a family trust. These gains are profits on the sale of an investment. Capital gains form part of your income tax and are required to be reported in the trust tax return. A capital gain is added to the taxable income, whereas a capital loss can be offset against any taxable capital gain. Asset acquired pre 20th September 1985 are exempt from capital gain tax. There are also other CGT exemptions that relate to personal assets, for instance, your principal place of residence, car, and furniture. Further detail of these exemptions can be accessed via the ATO website.
The sale of an asset can trigger a capital gains event that results in either a capital gain or capital loss. Proceeds from the sale would be used to calculate the net capital gain that forms part of the trust’s net income. The trust income once determined would be allocated/distributed to its beneficiaries. The income is prorated in line with the beneficiary entitlements specified within trust deed provisions. The trustee would be assessed at the highest marginal tax rate if no beneficiary of the trust is presently entitled to the income (currently 45%). The trustee cannot access the CGT discount therefore ensure that the trust has been set up correctly from the start.
Capital Losses
Capital losses incurred within the trust must be quarantined in the trust. This means that they cannot be distributed or transferred to increase an individual’s capital losses. These trust losses must first be applied to any trust capital gain. If there are no capital gains to be applied against then the trust losses are carried forward in the trust to future years.
Setting up a corporate trustee of the trust would be an option to provide the added benefit of asset protection. By the corporate entity acting as a corporate trustee it legally owns the assets within the trust. This structure offers additional protection against creditors and a strategy to transfer wealth across generations. For more investing tips read the guide to investing in the share market.
