Family trusts are commonly used to hold assets or operate a family business. Let's take a closer look at exactly what they are...
Family trusts are commonly used to hold assets or operate a family business. Let's take a closer look at exactly what they are, how they work and some of the advantages & disadvantages of using this structure.
What is a family trust?
Essentially a family trust (also known as a discretionary trust) is a relationship where a trustee holds property or assets for the benefit of a beneficiary or beneficiaries. It is usually established by a small gift (eg $10), by a person called the settlor. This person is unrelated to the persons who are intended to benefit from the trust (for example a lawyer, accountant or friend).
How do they work?
They work in a similar way to a parent opening a bank account for a child. While that account and the money belong to the child, the parent is the person responsible for and ultimately in control if that account. With a family trust, the trustee is the legal owner of assets of the trust.
The trust is governed by the trust deed, and there are some important things to consider when setting up a family trust. This includes who the Appointor will be - this individual can appoint and remove the trustee. It is often said that the Appointor has the most important role in a family trust, and has ultimate control of the operation of the trust.
The deed will also stipulate the primary beneficiaries, and a wide range of potential beneficiaries , who are usually members of a family (family group). The deed typically won't name these potential beneficiaries, they will be included by their relationship to the primary or default beneficiaries. The family group would also include companies or trusts that are controlled by that family.
The Trust and the Trust Deed
The trust is a legal relationship or structure between the trustee and the beneficiaries. All assets placed into the trust are controlled by the trustee for the benefit of one or more third parties (the 'beneficiaries'). The trust deed is a document that sets out the terms and conditions on which a trust is established, how it must operate and how the trust is to be terminated (wound up). The trust fund is held by the trustee and administered in accordance with the terms of the trust deed. The trust has a life span (usually 80 years), unless the trust assets are distributed earlier to the beneficiaries, and the trust is wound up.
Can be an individual, individuals or a company. In most cases, the trustees are usually the parents or a company they own. As mentioned, the trustee owns and controls the business' assets, distributes income and must comply with the obligations of the trust deed. The trustee is also responsible for lodging trust tax returns, and meeting other tax obligations on behalf of the trust.
These are the people entitled to the income and assets of the trust. Beneficiaries will generally include their share of the trust's net income as income in their own individual income tax returns (together with income from other sources - such as wages, income from investments and other businesses).
Family Trusts: benefits
Asset Protection: assets that are within a family trust are protected from creditors. Business owners face significant risk in operating a business - they may be sued personally or potential bankruptcy. This means, if a claim is made against you, the assets are not in your name and therefore cannot be accessed in these circumstances.
Tax Advantages: The typical structure of a company acting as trustee enables the limited liability benefits of a company structure, whilst taking advantage of the tax flexibility benefits. For example, the trustee can determine which beneficiaries can benefit from the trust, and this can change from year to year. This is done by way of a resolution.
Other benefits: using a family trust can protect vulnerable beneficiaries who may make poor spending decisions if they were to control their own assets. Also assets held within the trust do not form part of a deceased estate. This can prevent contests to a will or your child's spouse claiming their share of an inheritence.
Playing by the rules: Any income earned by the trust not distributed to the beneficiaries, is taxed at the top marginal tax rate. The trust cannot allocate tax losses to beneficiaries. Care must be taken in making changes, including adding beneficiaries, as changes could constitute a resettlement - which could result in capital gains tax and stamp duty liabilities. It is important to seek legal advice before any changes are made to the trust.
Maintenance: a family trust requires ongoing accounting and tax advice including annual accounting financial statements and income tax returns. There are also meeting minutes and resolutions that need to be prepared, which documents the decisions and actions of the trustee.
Is a family trust right for me?
Entering into a family trust needs careful consideration and planning. At Hailston + Co, our expert team of accountants and tax advisors can help you navigate through the complexity to help you decide if a family trust is right for you and your business.
Disclaimer:This article contains general advice only. It does not take into account you or your family's individual needs, objectives or financial situation. You should consider seeking advice from a financial planner or other professional advisor before making any financial decisions based on this information.