What’s the tax rate on a trust in Australia?

Understanding trust taxation basics

In Australia, a trust doesn’t pay tax on its income in the same way individuals or companies do. Instead, the trust distributes income to its beneficiaries, and those beneficiaries are taxed at their personal income tax rates. This is why a trust can be beneficial; you may be able to distribute the trust’s income in a way that reduces tax obligations for particular individuals (i.e. trust beneficiaries).

But there can be situations where the trust itself is taxed, and this comes with different rules and rates.

What is the tax rate on a trust?

The tax rate on a trust depends on whether the income is distributed or retained within the trust:

1. Income distributed to beneficiaries:

When a trust distributes its income to beneficiaries, the beneficiaries include that income in their personal tax returns and pay tax at their marginal tax rate. This can range from 0 per cent to 47 per cent, depending on their taxable income.

2. Income retained in the trust:

If a trust retains income instead of distributing it to beneficiaries, the Australian Tax Office (ATO) imposes the top marginal tax rate of 47 per cent. This acts as a deterrent to retaining income within the trust rather than distributing it to beneficiaries.

Tax rules for different types of trusts

Family trusts

Family trusts (also known as discretionary trusts) are often used for tax planning because trustees have the flexibility to distribute income to beneficiaries in a way that minimises the overall tax burden.

For example, income can be allocated to beneficiaries with lower marginal tax rates—such as adult children or non-working spouses—to reduce the total tax payable.

Unit trusts

Unit trusts work differently. Beneficiaries (referred to as unit holders) have fixed entitlements to the trust’s income and capital, proportional to their units in the trust. While unit trusts don’t offer the same flexibility as family trusts, they are often used for investment purposes, such as pooling funds for property or business ventures. They can be incredibly tax effective in this way (and it’s why we prefer using unit trusts in our property syndicates).

Like family trusts, unit trusts distribute income to beneficiaries, who then pay tax on their share at their individual tax rates.

How the tax rate impacts investments

The tax treatment of trusts directly affects the return on investments. Distributing income to beneficiaries with lower tax rates ensures more of the investment income stays within the family or group. On the other hand, if income is retained in the trust, the top tax rate of 47 per cent can of course significantly reduce returns.

For example:

• If a family trust distributes $20,000 to an adult beneficiary with a marginal tax rate of 19 per cent, the tax payable is $3,800.
• If the same $20,000 is retained in the trust, it would incur a tax bill of $9,400 at the 47 per cent rate.

Clearly, strategic distribution makes a big difference in preserving wealth and optimising investments.

Why trusts are beneficial at tax time

Trusts offer several advantages, especially during tax time:

1. Tax efficiency: By distributing income to beneficiaries with lower marginal tax rates, trusts can minimise the overall tax burden for families or groups.
2. Asset protection: Trusts can shield assets from creditors or legal claims, which is particularly useful for business owners or high-net-worth individuals.
3. Estate planning: Trusts allow for smooth transfer of wealth, ensuring that assets are distributed according to your wishes while potentially reducing tax liabilities for beneficiaries.
4. Capital gains tax (CGT) discounts: If the trust sells an asset held for more than 12 months, beneficiaries may be eligible for the 50 per cent CGT discount when the gain is distributed to them.

Are trusts right for you?

Whether you’re using a family trust to manage household income or a unit trust for investment purposes, understanding how the tax rate on a trust works (in other words, how you are taxed as an individual as a result of your trust distributions) is essential for making the most of your wealth.

Of course, if you’re unsure how to structure a trust or distribute income to minimise tax, it’s a good idea to consult a financial adviser or tax professional.