Meggs says his firm has been educating clients on the ATO’s shifting focus since 2014. But more broadly, he says his firm doesn’t try to pitch family trusts based on their tax benefits.
Instead, he believes family trusts are more useful for asset protection.
Family trusts are a type of legal entity set up to hold assets for the benefit of the family members within the trust. As the assets within the trust are considered to be held by the trust, rather than by the beneficiary, the trust can offer an additional layer of legal protection.
“It’s much harder for a creditor to attack or take those assets away [from a family trust],” says Meggs.
For that reason, people in the medical profession, lawyers, engineers and business owners may consider establishing a family trust, simply as a means of shielding assets in the event they are sued.
“They’re not just for rich people. In fact, they’re easier and more popular today than ever before,” says Meggs.
“At the end of the day, you can set up a trust for a couple of thousand dollars. If you’re going into business and you want to protect your assets, they’re a great tool.”
2. Keeping the family business in safe hands
Kelly Pillay, principal at financial planning firm KLI Group, says the main reason she sees people set up family trusts is for asset protection. She adds, however, that owning a family business can also be a valid reason to set one up.
That’s because a family trust allows the trustee discretion to decide how to distribute income to beneficiaries. Family trusts also offer a 50 per cent capital gains tax discount on any capital gains made upon the disposal of assets held for longer than one year.
“If you’ve got children who are coming into an established business over time, the family trust gives flexibility to plan those things,” she says.
“It gives the family the ability to share that [business] profit and develop that person over time, without having to trigger tax consequences and ownership issues in transferring assets between people’s names.”
Most businesses will generally require some sort of structure to run the business, adds Want, but that doesn’t mean it needs to be a trust.
“If your business is only turning over a few thousand dollars, you’re selling something down at the markets once a month or something like that, unless you’ve got a huge asset-protection need to have to run it through a trust, you’ll probably run it through your own name,” he adds.
However, someone who is running a business full-time with employees may be more likely to use a family trust structure.
The longevity of family trusts – they can last for up to 80 years – also makes them popular among family businesses.
“You can start a business today and have your grandchildren take control and run that, without having to transfer that business and pay capital gains tax along the way as you exit it and retire or pass away,” adds Meggs. “From a legacy perspective, that’s really good too.”
3.Thinking about the future
Family trusts are also useful in estate planning, says Want.
“Obviously, if someone were to pass away, their will deals with the assets in their name. But depending on how they’ve structured their affairs, things like trusts can be dealt with separately.”
For example, if parents or grandparents are on the top tax rate and building up assets in their own names, selling those assets may incur large tax bills.
“[But] if they’re doing that through a trust, when they sell those assets, that capital gain might be able to be distributed to the grandchild and taxed in the grandchild’s name,” says Want. “If the grandchild has little or no other income, it could be a very tax-effective way to do it.”
Additionally, if a family is building up significant wealth, they may choose to set up a trust and add assets to it over the years. Then, once children or grandchildren are old enough, assets in the trust can be sold and distributed to them – perhaps when they’re in their 20s or 30s and considering buying their first home.
4. Save on tax
While the ATO is watching distributions made to family members on lower tax rates, parents can still provide financial support to children through trusts, says Meggs.
“What I’ve been saying to clients is, ‘You know you’re going to be paying your kids’ uni fees, you know you will buy them a car, you know that you might pay for a wedding or a house deposit’ .
“Rather than just giving them money for that on the side, the parents just need to pass them the cash [through the trust] and let them pay for the car, let them pay for their own university fees.”
The accompanying tables illustrate the tax savings when this is done. Take two parents earning $250,000 each a year who want to give their adult university student child $75,000 to cover university, residence and living expenses. They’re better off by just over $22,000 doing this via a family trust.
Parents earning $190,000 each a year wanting to give $18,200 to an adult university student child would save almost $9000 by doing this via a family trust.
One of the benefits of making distributions in this way is a greater opportunity to increase financial literacy, adds Meggs.
“It’s a great way to say, ‘Well, because that is your money, if you want that for a house deposit and you don’t need it in the short term, why don’t we work with our financial adviser to help you invest that in a way that’s consistent with your goals?’
“It’s a good way for advisers to get that next generation of people and educate them.”
Where to next for trusts?
All three experts agree the ATO’s rules are fair, but warn the crackdown is only just beginning.
Meggs suspects there will be a test case at some point that will go through the courts.
“By the time that happens, people probably will have changed their behaviors because they’re not going to want to get audited. It’s a big stick from the tax office,” he says.
“But as a result of that change in behaviour, there’s probably going to be political scope for a legislative fix.”
Pillay, who has seen an increasing number of requests for help in establishing family trusts, believes the ATO focus will prompt many families to revisit the way they’re operating their trusts.
“They’ll start to formalize the family arrangements that maybe previously had been a bit ad hoc or a bit all over the shop,” she says.
And, adds Want, it’s a good reminder that not everything can be solved with a trust.
“One of the key messages with family trusts is that people should sit down and talk to their accountant or adviser about how the trust operates, and not be afraid to restructure or no longer use it,” says Want.
“Most people would prefer their affairs are kept as simple as possible to achieve what they need to achieve. That doesn’t mean they always need a trust. Sometimes not having it is not only perfectly legitimate, but the best thing for them.”