Not all trusts, and trust distributions, are created equal. 

There are many advantages and disadvantages to be considered for each trust structure and its appropriateness for your individual situation. One major consideration, that can be a positive or a negative, is the tax treatment for income and assets in various trust structures.

Let’s take a look at the tax treatments that apply when it comes to testamentary trusts.

Tax Treatment of Trust Distributions

In order to better understand the complexities of tax in regards to income and distributions from testamentary trusts, it is important to first understand the broader application of tax obligations in regards to the majority of trust income and distributions.

For the most part, adult beneficiaries are taxed at their applicable marginal tax rate for any income or distributions received from a trust.

Trust distributions received by minors (persons under 18 years) are generally taxed at the top marginal tax rate. This condition is in place to negate any potential tax benefits that may be obtained via arrangements whereby adults divert their income to minors through the trust.

However, under the Income Tax Assessment Act 1936 (Cth.), minors can be taxed at the ordinary adult individual tax rates for ‘excepted trust income’ prescribed under section 102AG, of which some income from a testamentary trust is included.

What is a Testamentary Trust?

A “testamentary trust”, which is also known as a”trust estate” is a trust that is created as a result of: 

  • A will, codicil or an order of a court that varied or modified the provisions of a will or codicil; or
  • An intestacy or an order of a court that relates to the estate of a deceased person.

It is only established upon the passing of the testator, when their will or other intestacy arrangements come into effect.

The intention of a testamentary trust is usually to provide for the needs of the deceased’s children who have not yet reached adulthood, or may require a specific level of care.

Excepted Income in a Testamentary Trust

Prior to 1 July 2019, all assessable income from a testamentary trust was considered ‘excepted trust income’ when distributed to a minor. 

This allowed some taxpayers to inject assets unrelated to the deceased estate into the trust in order to inappropriately obtain the concessional tax treatment. 

To combat this, the Treasury Laws Amendment (2019 Measures No. 3) Act 2020 (Cth), enacted additional provisions to limit ‘excepted trust income’ of a testamentary trust to only include income derived from assets of the deceased estate or from the accumulation of such income. 

This is where things start to get a little complicated. 

Schedule 1 of the amendment inserted a new subsection (2AA) in relation to assets acquired by or transferred to the trustee of a trust estate on or after 1 July 2019.

(2AA) For the purposes of paragraph (2)(a), assessable income of a trust estate is of a kind covered by this subsection if:

(a) the assessable income is derived by the trustee of the trust estate from property; and
(b) the property satisfies any of the following requirements:

  1. (i) the property was transferred to the trustee of the trust estate to benefit the beneficiary from the estate of the deceased person concerned, as a result of the will, codicil, intestacy or order of a court mentioned in paragraph (2)(a);
  2. (ii) the property represents accumulations of income or capital from property that satisfies the requirement in subparagraph (i);
  3. (iii) the property represents accumulations of income or capital from property that satisfies the requirement in subparagraph (ii), or (because of a previous operation of this subparagraph) the requirement in this subparagraph.

The Explanatory Memorandum details that:

1.5: The existing law does not specify that the assessable income of the testamentary trust be derived from assets of the deceased estate (or assets representing assets of the deceased estate). As a result, assets unrelated to a deceased estate that are injected into a testamentary trust may, subject to anti-avoidance rules, generate excepted trust income that is not subject to the higher tax rates on minors. This is an unintended consequence, which allows some taxpayers to inappropriately obtain the benefit of concessional tax treatment.

1.6: Schedule 1 to the Bill clarifies that excepted trust income of the testamentary trust must be derived from assets transferred to the testamentary trust from the deceased estate or from the accumulation of such income.

The updated legislation and accompanying memorandum, clarifies that those items always intended to be excluded from being excepted trust income are now more readily enforceable.

Tax Treatment of Non-Excepted Income

As a result of the legislation, income from assets injected into a testamentary trust, that are unrelated to the original deceased estate, are to be taxed at the top marginal rate.

Such “unrelated” income might include:

  • injection of assets from the estate of the surviving spouse, and
  • borrowings by testamentary trusts

Stay Up-To-Date with the Changes

As you can see, the law in relation to testamentary trusts and taxation is certainly not a “set and forget” scenario. It is critical to constantly be aware of any changes that may affect your intentions and trust dealings so that you can take necessary action to minimise the impact for your assets and loved ones in the future.

Expert Advice for Testamentary Trusts & Tax

Dealing with taxation obligations can be complex enough in itself. When combining that with trust structures and legislation, things can then get even more complicated very quickly. It is important to seek expert advice to ensure that you are not only correctly meeting your legal requirements, but also legally minimising the amount of tax that you are required to pay.

The team of experienced tax lawyers and accountants at The Quinn Group can offer expert advice and guidance for your individual situation. Contact us by completing an online enquiry form or call 1300 QUINNS (1300 784 667) or on +61 2 9223 9166 to arrange a meeting or teleconference.