The disadvantages of family trusts.
The tax advantages of using a family trust are well known. Some flexibility exists with using a family trust as a tax structure. In certain situations, the potential exists to stream income to different members in the family group.
A family trust, like a company, is also a good way to protect assets from potential creditors in the case of financial trouble, or from other parties as the need may arise (eg, when a family member gets married and may be gifted property or money to buy a house).
So, even though a home held by a family trust is not entitled to the capital gains tax (CGT) main residence exemption, there may be other non-tax benefits that carry greater weight.
A family trust can also be used to help in business succession matters, for example, where farmland is held by a family trust where successive generations of a family can continue to farm it for their benefit.
Of course, to effectively use a family trust you need to have assets it can hold or acquire. It is of no use in trying to obtain tax advantages in respect of personal services income per se. You need for it to be able to hold assets, and preferably good income-producing assets.
However, for all their benefits there are a few demands associated with using a family trust.
For a start, if you wish to “stream” capital gains and/or franked dividends to certain beneficiaries, so that they retain their character as concessionally taxed amounts in the beneficiary’s hands, then there are some complex rules that must be followed. And if they are not followed properly you can end up getting a tax result far removed from what you intended. Oh, and the trust deed must allow streaming of gains (so you may need an updated deed).
Secondly, if a trust has capital losses it cannot, unlike a partnership, distribute those losses to beneficiaries.
They instead remain in the trust, and furthermore can only be used to reduce future taxable income or capital gains if certain “continuity of ownership” tests are met. And this often involves the need to make an irrevocable family trust election which locks the trust into distributing all its income to certain beneficiaries only.
Thirdly, contrary to common knowledge, distributions to children are not tax-effective in that they are usually taxed at penalty rates which equate to the top tax rate in most cases (albeit, you do get the benefit of a taxfree threshold of some $700).
Fourthly, trusts do not generally last forever (although in some state jurisdictions it is possible). At some stage the trust has to be wound up (usually after 80 years) and assets held by the trust have to be distributed to certain beneficiaries. And this can often trigger a CGT liability (and a large one at that). Just ask Gina Rhinehart and her family.
And there is also the question currently before the High Court of whether a company will be liable for Div 7A tax in respect of “unpaid present entitlements” made to it by a trust. This too is a hot issue in relation to if and how to use a family trust effectively for tax purposes.
So, the issue of whether to use a family trust is not always straightforward. Therefore, if you intend to use one, or think your current one needs some revisions, come and chat to us.
Questions about family trusts? Contact our team for advice.
Family trusts can be powerful structures when used in the right circumstances, but they are not a one size fits all solution. The complexity of trust rules, limitations around losses and distributions, potential tax consequences, and long term obligations mean that trusts require careful planning and ongoing management to remain effective.
If you are considering setting up a family trust, or if you already have one and are unsure whether it still suits your circumstances, professional advice is essential. Speak with our team to review your structure, understand the risks, and ensure your trust is aligned with your tax, asset protection, and long term planning goals.
For practical and professional guidance across family trusts, accounting, taxation, business advisory and financial planning, contact Stratogen Accounting. Based in Noosa, our experienced team of accountants and business advisors support clients throughout the Sunshine Coast and Australia-wide. From tax compliance and bookkeeping to strategic planning, risk management and long-term wealth creation, Stratogen is here to strengthen your financial position and support your success.