Your business is growing and consistently scaling up. It’s growing so well in fact your solicitor, accountant or other financial advisor has floated the idea of setting up a family trust. It seems like a great idea.
At the same time, we’re living in a world of uncertainty. People are looking to protect their family business and assets, and to safeguard against an unpredictable future.
Let’s take a closer look at family trusts. The pros, the cons and everything in between.
What is a family trust?
A trust is a legal relationship between the trustee, who controls the property held within the trust, and the beneficiaries, who benefit from the trust.
The ATO defines a trust as:
A trust is an obligation imposed on a person or other entity to hold property for the benefit of beneficiaries. While in legal terms a trust is a relationship not a legal entity, trusts are treated as taxpayer entities for the purposes of tax administration.
There are two main types of family trusts.
A family trust, or family discretionary trust
A family trust is set up to control and protect a family’s assets, and available only to family members. Common among small, private business owners, once established, the trust owns all assets and has the power to allocate income to family members. This income is not set and is issued at the discretion of the trustee. Income may be different for each family member and can change from year to year.
As the trust separates assets from a person’s estate, it’s particularly useful in protecting:
- individuals too young to handle their own financial affairs
- incapacitated or vulnerable people
- those who may squander the family fortune
- against potential legal or financial liability
Unit or fixed trust
Different to a family trust, as the trustee normally doesn’t have the discretionary power to determine the distribution of income. It’s more like share dividends, with each beneficiary receiving income proportional to their holdings. A fixed trust can also be set up between more than one family group.
Trusts are recognised across Australia and are relatively easy to set up and operate.
Why set up a family trust?
Setting up a trust allows the trustee to take control of the business and its assets. The trustee controls who receives payments, the terms of the payments, how much and when. This can be helpful when dealing with, for example, a surviving spouse or the children of multiple marriages or relationships.
A family trust will protect a family’s assets as the assets are not held in any one person’s name. Should you or another family member find yourself in legal or financial trouble, whether personal or professional, a trust affords you and your assets greater protection.
If you set up a company as the trustee for your family trust, you’ll have access to the additional limited liability benefits of the company structure, as well as the flexible tax benefits.
A trust can distribute business profits to beneficiaries in such a way as to optimise tax benefits. In other words, a family trust can make a business far more tax effective as the business grows and profits increase.
While a trust does have its own tax file number and is required to prepare an annual tax return, it doesn’t pay the tax if all income is paid to beneficiaries. The beneficiaries are then taxed on their marginal rate of tax. Therefore, by streaming profits to beneficiaries, depending on the tax brackets into which each individual falls, the opportunity to reduce taxes owing is obvious.
Why a family trust may not be your best option
Exponential business growth
If your business grows too big, with your profits increasing at the same pace, the trust will become progressively more complicated to manage, as will the tax planning. So there may be alternative business structures that are more appropriate for your business moving into the future.
Financially maintaining a family trust is an ongoing consideration. Eventually, the costs of running and managing an increasingly complex family trust may start to outweigh the benefits of the trust itself. This is where a great accountant who understands your business’s unique needs becomes important.
Income and tax
Income earned by the trust and not issued to beneficiaries will be taxed at the highest marginal tax rate. Income allocated to minor children is also taxed at the top marginal rate, plus the Medicare levy. Tax losses stay with the trust. They cannot be passed to beneficiaries to be used to lower their own income or tax debt. They can however be carried forward and used to offset future family trust earnings.
The Human Factor
Family disputes, challenges to a will, marriage or relationship breakdowns and bankruptcy can all make maintaining a family trust difficult. Control of a trust should the appointed trustee/s lose capacity or die, can also make things tough.
Every business and family is different. Deciding on whether to establish a family trust isn’t a decision to be made lightly. You should always seek sound financial advice from people who know and understand how to help you be better off.
Here at Kelly+Partners our expert accountants and advisers are committed to ensuring your business has in place the best business structure to suit your unique needs.
How do trusts work in estate planning?
Trusts are common in estate planning. This extends beyond one single kind of trust, as there are different kinds people look into to help them save money and add an extra layer of protection in the long run.
Testamentary Trusts and Family Trusts are two options we'll explore.
Testamentary Trusts only exist after a person has died. A will may contain more than one testamentary trust, and may address all or any portion of the estate. People may opt for a testamentary trust to protect their assets or for tax purposes.
This differs from Family Trusts which are valid while the person is still alive. This means when the individual passes away, the assets continue in the family trust and do not get pulled into the distribution of the estate. This is assuming the trust is set up properly.
If the family trust is not set up properly, all of the benefits you're after are effectively lost. This is because loans can be called upon when the executor is managing the assets of the deceased individual.
Interested in learning more?
If you have any questions about setting up a family trust, please contact your local Kelly+Partners office today or give us a call on 1300 932 584. You can also request a call back at a time that suits you.