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Distributing income to Trust beneficiaries is a good way of reducing Trust taxation but there are a few pitfalls for the unwary.
Trust income is taxed at 33%. However you can distribute income to beneficiaries who are at a lower tax rate to reduce the tax payable by the Trust. Such distributions are generally achieved by the Trust retaining the cash and ‘owing’ it to the beneficiary and is recorded as a ‘beneficiary current account’ This income must then be declared in the beneficiary’s tax return.
Beneficiaries under the age of 16 can have $1,000 per year allocated to them as income at a tax rate of 19.5%. This is especially attractive where there are a number of young beneficiaries in a Trust. Another rule not commonly known regarding distributions to minors is that while the amount of the distribution is limited to $1,000 at 19.5 % from any single Trust, there is apparently no limit to the number of Trusts that can distribute $1,000 each to the same beneficiary (however commentators have noted that setting up multiple Trusts specifically for this purpose would in all probability fail as a tax minimisation scheme)
The pitfall of distributing to beneficiaries in this manner is that this is a real debt owing by the Trust. From the Trustee’s perspective it was merely a convenient way of legitimately minimising tax. The beneficiary is neither advantaged nor disadvantaged as the Trust pays the tax on the extra income they are required to declare.
However, once a beneficiary turns 20, (suis juris) he/she can demand payment of the outstanding sum and there is very little the Trustees can do about it.
The key to managing beneficiary current accounts is good record keeping. Most minor beneficiaries would in their early years most probably receive much more than $1,000 per year in educational expenses alone. Using Trust funds to pay these expenses should offset profit distributions over the years, thereby keeping current account balances to a minimum.
Another way (albeit rarely used) of reducing current accounts is to merely have suis juris beneficiaries ‘gift’ them to the Trust, in the same manner that you make gifts to the Trust.
There are many more reasons for good record keeping in Family Trusts. However, the ramifications of failing to properly record and manage beneficiary current accounts can be far reaching and potentially disastrous....(unless you can state beyond doubt that your little darlings will be the same loving, trusting, non judgemental individuals in their 20’s as they are now......)
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