The law around excepted trust income and Testamentary Trusts has changed!
Recently the law around excepted trust income under Testamentary Trusts (distributions of income to minors and/or utilising tax free thresholds and low income tax offsets) has changed. The changes were first announced in the 2018 Federal Budget, they were then drafted in July 2019, they were passed recently in June 2020 and they apply from 1 July 2019. The amendments mean that any income from assets transferred to a Testamentary Trust on or after 1 July 2019 will not be excepted trust income UNLESS the assets were transferred to the Trustee of the Testamentary Trust from the deceased estate or from the accumulation of such income.
How is the new law different to the old?
Under the old law (assets pre 1 July 2019), income from assets in a Testamentary Trust that weren’t originally part of the deceased’s estate were still considered to be excepted trust income and tax savings from this excepted income were able to be distributed to minors or adult children who could access tax free thresholds and low income tax offsets (around $20,000 per year per child).
The new law does not allow for this and aims to ensure that Testamentary Trusts are only utilised for the assets left behind by the deceased in their estate and that they can no longer be used as tax saving vehicles in exactly the same way.
What does this mean for Testamentary Trusts?
If you have a Testamentary Trust that is already operating, any assets of the Testamentary Trust before 1 July 2019 will automatically be deemed to be assets of the deceased estate and can continue to be utilised for excepted trust income into the future (yay!). However, if your Testamentary Trust is not yet operating (so you’ve set one up or want to set one up in your Will and you’re still alive) OR assets have been added to an existing Testamentary Trust on or after 1 July 2020, then it may affect how the Testamentary Trust can utilise the tax savings associated with excepted trust income moving forward.
The assets must be from the deceased estate AND be classified as one of three types of property
The new law provides that in order to qualify as excepted trust income, the asset the income is derived from needs to be from a deceased estate AND also property from one of the three following categories:
Property that the Trustee of the Testamentary Trust has received from the deceased estate; or
Accumulations or reinvestments of those deceased estate assets; or
Re-investments of reinvestments of those deceased estate assets.
What does this mean for Superannuation and Life Insurance?
Without further interpretation from the Australian Tax Office, it is unclear whether a deceased person’s Superannuation and Life Insurance benefits will be deemed an estate asset of the deceased when they are injected into the Testamentary Trust and therefore be able to be dispersed as excepted trust income. It is likely that if the beneficiary of the policy/s is the Legal Personal Representative of the deceased person’s estate then they should still qualify as an estate asset of the deceased, however, if an individual is nominated as the beneficiary then it is unlikely that the money will be considered an estate asset of the deceased under these new laws.
Setting up a Binding Nomination where the Legal Personal Representative of your estate is the nominated beneficiary is likely the best way to ensure that your Superannuation and/or Life Insurance proceeds can be considered excepted income for distribution in your Testamentary Trust – subject to any future rulings from the Australian Tax Office.
If you have a Family Trust – the way Testamentary Trusts are used could change!
Under the new laws, any distribution into a Testamentary Trust from a Family Trust WILL NOT be excepted income. The ATO has provided the following example:
Lavender Trust is a testamentary trust established under a will of which Alex is a beneficiary. Alex is 14 years old. As a result of the will, $100,000 is transferred on 17 July 2019 to the trustee of Lavender Trust from the deceased estate. Shortly after, the trustee of a family trust makes a capital distribution of $1 million to the trustee of Lavender Trust. The trustee of Lavender Trust invested the entire amount of $1.1 million in listed shares.
In the 2019–20 income year, the trustee of Lavender Trust derives $110,000 of dividend income from the investment in the listed shares. The net income of Lavender Trust for that year is $110,000. Alex is made presently entitled to 50% of that amount, which is $55,000.
Alex's excepted income is $5,000. This amount is the extent to which the $55,000 of income resulted from the $100,000 transferred from the deceased estate (worked out as $100,000 ÷ $1.1 million × $55,000). The remaining $50,000 is income that resulted from the $1 million capital distribution from the family trust, which is unrelated to the deceased estate. It is not excepted income.
If you operate a business or the Trustee of your Testamentary Trust will need to borrow money – the way Testamentary Trusts are used could change!
Under the new laws, any loans that the Testamentary Trust takes out will not be eligible. For example, the ATO has provided the following example:
Johnston Trust is a testamentary trust established under a will into which $500,000 is transferred from the deceased estate on 22 August 2019. A trustee of a family trust then makes a capital distribution of $500,000 to Johnston Trust. The trustee of Johnston Trust borrows $1 million from a bank and purchases a rental property for $1.9 million. The remaining $100,000 is used as working capital for the rental property.
In the 2019–20 income year, the trustee of Johnston Trust receives $50,000 of net rental income. The net income of the trust for that year is $50,000. Michael, who is under 18 years old, is made presently entitled to 50% of the $50,000 net income, being $25,000.
Michael's excepted income is $6,250. This amount is the extent to which the $25,000 of income resulted from the $500,000 transferred from the deceased estate (worked out as $500,000 ÷ $2 million × $25,000). The remaining $18,750 of income is attributable to assets unrelated to the deceased estate and is not excepted income.
This is particularly important for anyone operating a business as it is likely that the business will need to borrow money to continue to operate or purchase future assets, etc. It may get complicated in terms of determining the percentage of income which is excepted trust income where loans are involved. It may be advisable, depending on your situation, to have separate Testamentary Trusts if you operate a business – one for any assets that you own outright and one for the business that may need to borrow money – that way you can keep a clear distinction between the assets that are eligible for excepted trust income without making any adjustments.
Testamentary Trusts can be complicated, so it is important to seek legal advice to ensure that your Will is set up appropriately and tailored to your unique situation. These new laws add a further layer of complication to Testamentary Trusts and while there are absolutely still benefits of setting them up, it is important to get legal advice from a succession law expert to ensure that your Testamentary Trust in your Will is drafted appropriately.
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