Clients often wish to transfer estate assets into an existing Family Trust. This is because they want to use the accumulated tax losses in the Family Trust. This is often a mistake. It triggers Division 6AA penalty tax rates and risks “trapping” losses under Schedule 2F. The superior strategy is to establish a 3-Generation Testamentary Trust and distribute income to the Family Trust.
Can I gift assets in my Will to my Family Trust?
Many of the 4,600 accountants, lawyers and financial planners who build documents on our website have told us that their clients ask a specific question.
The client controls a Family Trust with accumulated losses. These losses usually arise from negative gearing or business downturns. The client also owns personal assets that have accrued significant capital gains.
The client asks their adviser:
“Can I leave my personal assets to my Family Trust in my Will? I want to use the Trust losses to offset the income from my assets.”
The answer is yes. You can achieve this outcome with a 3-Generation Testamentary Trust Will. However, you should generally avoid allowing the tax-effective estate assets to be lost to an inter vivos family trust.
Why mixing Estate and Non-Estate assets destroys Section 102AG status
If you leave assets directly to your existing Family Trust, you step into a tax minefield. You are mixing “estate assets” with “non-estate assets”.
Family Trusts are inter vivos trusts (trusts created during your lifetime). Distributions to minors (beneficiaries under 18 years of age) are penalised. Under Division 6AA of the Income Tax Assessment Act 1936, minors are taxed at the top marginal rate on “unearned income” over $416. This is up to 66%.
However, a 3-Generation Testamentary Trust in your Will accesses Section 102AG of the Income Tax Assessment Act 1936. This section classifies income as “excepted trust income”. This allows minors to be taxed at adult rates, access the full tax-free threshold, and be subject to progressive tax brackets.
The “Tainting” of Excepted Trust Income when assets in a Will go into a Family Trust
You cannot convert an existing Family Trust into a Testamentary Trust. The courts are strict on this distinction.
For income to be “excepted” (tax-free for minors), it must derive from property that passed directly from the deceased estate.
If you transfer your estate assets into your old Family Trust, you are “injecting” capital into an inter vivos vehicle. Those assets lose their “Testamentary” character. Consequently, you lose the Section 102AG protection. Income generated from those assets is now taxed at 66% or 45% for your minor grandchildren.
Schedule 2F Trust Loss Provisions: The “Trapped Loss” Risk of estate assets going into a family trust
Your accountant will tell you that transferring assets to the Family Trust often fails to utilise the losses anyway.
Schedule 2F of the Income Tax Assessment Act 1936 contains complex “Trust Loss Provisions”. These rules prevent the trafficking of tax losses. To claim the losses, the Trust must pass strict tests.
When you die, the “control” of the Family Trust often changes. This change in control can cause the Trust to fail these tests. The losses become “trapped” and unusable.
Your accountant applies these four tests from Schedule 2F:
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50 Per Cent Stake Test: Has more than 50% of the underlying ownership changed? (Section 267-30)
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Pattern of Distributions Test: Has the trust been distributed to different people than it used to? (Section 267-35)
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Control Test: Has the trust’s control shifted? (Section 267-40)
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Income Injection Test: Are you injecting income just to use the loss? (Section 270-10)
In Raftland Pty Ltd v FCT (2008) 238 CLR 516, the High Court took a “substance over form” approach to trust control. If the control changes upon your death, the losses may vanish.
Instead of distributing Income via a 3-Generation Testamentary Trust
Do not move the assets to the losses. Instead, move the income to the losses.
The LegalConsolidated 3-Generation Testamentary Trust is uniquely flexible. It allows your accountant to execute a specific strategy to overcome this problem without tainting the assets.
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Establish the Legal Consolidated Trust: Your Will creates a 3-Generation Testamentary Trust upon your death. This preserves the CGT Rollover relief under Subdivision 128-B of the ITAA 1997.
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Segregate the Capital: The dead person’s properties and cash are transferred into one or many 3-Generation Testamentary Trusts. This is as your beneficiaries wish. Because these are pure estate assets, they continue to enjoy the Section 102AG tax rates for minors.
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Beneficiary Nomination: The Legal Consolidated list of General Beneficiaries allows you to distribute to the Trustee of your old Family Trust as a beneficiary of your new 3-Generation Testamentary Trust.
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Streaming Income: Your executor distributes income (not capital) from the new Trust to the old Family Trust.
The old Family Trust receives the income. It uses its accumulated losses to offset that income. The tax payable is zero.
Meanwhile, the capital assets remain secure in the 3-Generation Testamentary Trust, protected from the “tainting” provisions. You achieve the best of both worlds.
Build a 3-Generation Testamentary Trust
Standard Testamentary Trust Wills lack the flexibility to distribute to other trusts or entities. They force rigid distributions that trigger tax.
Build your 3-Generation Testamentary Trust on our website today to ensure your wealth is not eroded by the Australian Taxation Office.