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Taxation Benefits Explained

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A Case Study – Taxation Benefits of a Discretionary Trust

Mary wants to leave her estate to her husband Tom. Tom currently pays the top marginal tax rate (including Medicare levy) of 47%.  Mary and Tom have 2 minor children who attend private schools and don’t earn any income. Assume that on her death Mary’s estate, if invested, would generate income of $40,000 per year.

If Mary left her estate to Tom outright (ie not in a discretionary testamentary trust) and he received the $40,000 income per year then Tom’s after-tax position would be:

Income $40,000
Tax + medicare levy $18,800
Low income tax offset (only applicable where taxable income is less than $66,667) nil
Net Income after tax $21,200

If the income was divided equally between Mary and Tom’s children (either via an existing family trust or an outright gift), the after tax position of the children would be:

  Child A Child B Combined
Income $20,000 $20,000 $40,000
Tax * $9,000 $9,000 $18,000
Net Income after tax $11,000 $11,000 $22,000

If instead Mary leaves her estate to a discretionary testamentary trust with Tom as the trustee and the trust income is distributed equally between Mary and Tom’s children, the after-tax position would be:

  Child A Child B Combined
Income $20,000 $20,000 $40,000
Tax ** NIL NIL NIL
Net receipt $20,000 $20,000 $40,000

Summary of benefit

The discretionary testamentary trust saves $18,800 tax per annum, leaving more available to spend on the children’s education and welfare. The tax savings that can be achieved by using a testamentary trust will depend on the individual circumstances of the Willmaker and their family members. In particular, it will depend on the tax position of their adult beneficiaries, how many children under 18 those beneficiaries have and the tax position of those children.

Note: the example assumes:

*   trust distributions to minors are taxed at 45%
**  in a testamentary trust minors can receive tax free distributions up to $18,200 (2014/2015) or $20,542 (if low income tax offset applies)
*** the calculations are based on the individual tax rates for the 2014/2015 tax year and are subject to change

The information contained in this fact sheet is general in nature and should not be relied upon as legal advice.  Legal advice should be sought for specific matters. If you have any questions please phone 1800 555 777 and speak to one of our specialists.