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Family trusts can be a powerful tool for a variety of wealth creation and protection reasons.
These include building wealth, protecting assets, generating improved cash flows, managing distributions to family members, creating flexibility as well as assisting with estate planning.
But like all good things, there can be a downside, too.
Unfortunately, if incorrectly used, a Family Trust can create serious financial repercussions.
The secret is understand what these are at the outset to ensure you’re not one of the people who makes one of these common mistakes.
1. Taxes on foreign income distribution
The thing is the definition of a foreigner is very broad.
Family trusts allow for a very flexible distribution of income to a wide variety of people in your family group.
Plus, this income distribution can range from nil to all of the trust income in any year.
What this means is that if the beneficiaries have a relative who is a foreigner, that person would be entitled to be considered for a distribution.
Under recent legislation, therefore, the various state governments would see this as falling within the foreigner category and would apply the higher taxes to the trust.
Here’s the point…
An actual trust distribution does not need to be made to the foreigner!
The mere fact that it is possible to make such a distribution is enough to be caught out.
Fortunately, there is a solution that ensures that your Family Trust is not impacted by the new State foreign ownership rules – if the right clauses are included.
2. Trust loss lessons
A Family Trust allows for the distribution of income to any family member.
However, if the trust has a loss it is trapped inside of the trust and needs to be funded with after-tax income.
This is because the use of this type of trust does not push down losses to a taxpayer to claim against their PAYG income.
As an example, if the trust holds a property where the rent is insufficient to cover interest and other costs – so it’s negatively geared – then the loss is trapped inside.
The bank and other suppliers still need to be paid but this is achieved without getting a tax deduction.
Any accumulated losses in the trust are available to offset future profits, including a capital gain.
This issue can be adjusted, with the correct advice and implementation, to allow any negative gearing to effectively flow down to the taxpayer.
The end result being that the losses will be offset against PAYG tax to improve cash flow.
3. Asset protection issues
Family trusts are a great structure for asset protection.
However, in many cases, they are set up with an individual person as the trustee, which effectively neutralises a major component of asset protection.
For example, if the trust is sued, say, by a tenant, the trustee would be at risk, as would any personal assets.
The appropriate trust amendment can fix this but if not correctly implemented it could trigger a full stamp duty event.
Family trusts can be a valuable tool, especially for families who want to share the financial fruits of their success.
However, it’s vital that you access professional advice before considering whether Family Trusts will benefit your long-term wealth creation and protection goals.
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