Understanding family trust elections

Choosing whether to make a family trust election?

As the Australian Tax Office (ATO) intensifies its focus on family trust distributions, the decision on whether to make a family trust election has become an important consideration.  

A family trust election is a formal choice that a trustee makes to have their trust treated as a ‘family trust’ for tax purposes. This decision is made once by lodging a Family Trust Election form with the ATO and nominating this on the Trust’s Income Tax Return. Once made, it stays in place indefinitely and can be difficult to revoke or change.

Trustees typically opt for a family trust election so they can:

• access tax concessions available only to family trusts
• carry forward and use prior-year losses within the trust
• distribute franking credits to family members over $5,000

A family trust determines who can legally receive trust income or capital through its trust deed. Put simply, beneficiaries must fall within the ATO’s definition of the ‘family group’ to receive distributions without attracting adverse tax consequences.  

The family group centres around a nominated person known as the ‘test individual’ and includes their spouse, children, grandchildren, parents, grandparents, siblings and their spouses, and any companies or trusts controlled by those family members.

Distributing to people outside the family group

Distributions to people who do not fit within the definition of the family group is the issue at the centre of the ATO’s new audit activity.

Family trust elections have been named a key priority within their Next 5,000 review program, and has already resulted in significant tax bills for incorrect distributions. These are taxed at the top marginal rate (45%), with the potential for interest and penalties and only 28 days to pay. Appealing the debt requires going to the Federal Court, because once the debt is determined the ATO cannot waive it. They only have the power to waive interest and penalties.

The key risk for family trusts is that the ATO has no limitation period when it comes to Family Trust Distribution Tax liabilities. Under the Family Trust Distribution Tax (Primary Liability) Act 1998, the tax is imposed automatically when a trust makes a distribution that does not comply with the family trust election rules. This is not a standard tax assessment, so it’s not subject to time limits like those in section 170 of the Income Tax Assessment Act 1936. Even distributions made 20 years ago can trigger Family Trust Distribution Tax, with penalties automatically applied.

Such actions have put the spotlight on family trusts and highlighted the importance of making an informed decision on whether to make a family trust election in the first place.

For example, let’s say you want to distribute income from your trust to your favourite aunt. Within a general discretionary trust, the trustee can elect to do this any time as long as it falls within the rules of the trust deed. You cannot, however, do this if you have made a family trust election, as aunts do not fall within the ATO’s classification of the family group. 

Weighing the pros and cons of a family trust election

While there may be no way to go back in time and fix an incorrect distribution, there are actions you can take to prevent future non-compliance. 

Before committing to a family trust:

1. Have your accountant review your finances and the proposed trust structure to determine if making a family trust election is genuinely beneficial.
2. Consider legitimate alternatives for accessing franking credits, such as using other investment structures or entities that can receive franked dividends.
3. Ensure you fully understand the rules of a family trust, including the family group and distribution obligations.

If you have already made a family trust election:

1. Choose the right test individual carefully, as the family group (including who can legally receive trust distributions) is defined around this person.
2. Keep distributions simple and compliant to ensure income is only paid to members of the defined family group.
3. Where necessary, plan income flows to the family trust versus other entities in a way that meets all tax and compliance requirements.

Of course, there will always be situations where a family trust election makes complete sense. However, this isn’t always the case, and making a family trust election without considering the long term consequences is a mistake that has definite repercussions later on. 

Leverage RSM’s insights on family trusts

As skilled accountants with extensive experience in all forms of trusts as well as commercial entities, our team can support you with valuable insights on how best to structure your affairs.

We take the time to understand your specific situation and long term goals so we can recommend a course of action that aligns with your objectives while maintaining compliance.

If you are concerned about non-compliance with family trust distributions, we can also assist in reviewing your family trust arrangements and provide practical advice on how best to move forward. 

For further assistance, reach out to your local RSM office.