Watch Out for the Family Trust Tax Trap

Family trusts are a powerful tool for building and protecting family wealth. But when it comes to the tax rules, there’s one feature that can trip people up: the Family Trust Election (FTE).

At Bonerath & Co, we help clients get this right, because while making an FTE can unlock valuable tax concessions, it also comes with strict rules. If the trust steps outside those rules, the penalty is harsh.

Here’s what you need to know about how FTEs work, and how to stay on the safe side.

What’s a Family Trust Election (FTE)?

A Family Trust Election is a formal choice made by the trustee of your family trust. This basically tells the tax office who the “main” person in the family group is (the test individual), and ensures you get certain tax benefits when distributing income within the family.

But once that election is made, the trust can generally only distribute income (or provide loans or benefits) to people within that family group. 

Once the election is made:

• The ATO will formally recognise your trust as a family trust.
• You can access certain tax benefits (especially around franking credits and prior year losses).
• But you can only distribute income (or provide benefits) within that defined family group, or you risk triggering Family Trust Distributions Tax (FTDT) at 47%.

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You Could Trigger a 47% Tax

If you make a payment, loan, or distribution to someone outside the family group — even if it’s by mistake — you could trigger the Family Trust Distributions Tax, which is a whopping 47%.

This can happen easily through:

• Poor or outdated records of beneficiaries
• Loans or payments made without checking the rules
• Not updating your trust after a death, divorce, or family restructure
• Misunderstanding who is “in” or “out” of the family group
  
  

The rules also apply across multiple trusts. So if your family has more than one trust, it’s essential that they’re all aligned properly.

Why Would You Make a Family Trust Election?

For many trusts, an FTE makes sense for tax optimisation, especially if the trust:

• Receives franked dividends. An FTE allows the trust to pass franking credits to beneficiaries (even if those beneficiaries can’t meet the usual holding period rules).
• Has revenue losses from prior years. Trusts without an FTE must pass multiple complicated loss tests to deduct past losses. With an FTE in place, only a simplified version of one test (the income injection test) applies.

Without an FTE, these benefits are either not available or are much harder to access.

Why Getting it Right Matters Now

The ATO is paying closer attention to family trusts, especially long-standing ones, or those involved in transferring wealth to the next generation. We’re seeing increased scrutiny on whether trusts are following the FTE and FTDT rules properly.

And once a mistake is made, it’s hard (and expensive) to fix.

How to Stay on the Safe Side

Here are some simple steps to protect your trust, and your wealth:

• Know your family group. Make sure you understand exactly who is covered by your Family Trust Election.
• Keep your records up to date. Regularly check your trust deed, beneficiary list, and any loans or payments made.
• Get advice before making changes. Before distributing income or changing anything in your trust, check in with your accountant.
• Plan for succession. If the person named in your trust as the “test individual” passes away or becomes unsuitable, act quickly to review and update your trust setup.

We’re Here to Help

If you have a family trust, or are thinking about setting one up, it’s essential to get the structure right and stay on top of the rules.

At Bonerath & Co, we’re here to help you manage the risks and make the most of the benefits, without falling into the 47% tax trap.

Need a trust health check? Let’s have a chat. Book a review with us today.

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