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Taxation of Minors and Testamentary Trusts – Change to Tax Law

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Section 102 AG of the Income Tax Assessment Act (1936) has just been amended.

This amendment will have tax implications for existing Testamentary Trusts and people with testamentary trust wills where minor beneficiaries (such as children or grandchildren) expect to receive distributions of income.  

Why does this matter?

Section 102AG deals with how trust income is taxed in the hands of minor beneficiaries.

Generally, a penalty tax rate of the top adult marginal rate is imposed on minors as a disincentive to adults diverting income to them in order to pay less tax themselves. This currently means children will pay 47 cents in the dollar for every dollar above $1,307 received in a financial year.

However, some income is exempt from such treatment. Historically, income paid from a Testamentary Trust created by a will to a minor is considered ‘exempted trust income’ and doesn’t incur penalty rates.

This makes a Testamentary Trust a very useful planning tool for some will-makers who can establish these structures in their wills. They can be used, for example, either to a) allow the will-maker’s minor children to benefit from the trust without being penalised; or b) allow the will-maker’s adult children to less tax by streaming income from the trust to their spouses and minor children, rather than paying tax at their own marginal tax rates.

What has changed?

Section 102AG has now been changed so that it only applies to income derived from property transferred into the Testamentary Trust directly from the estate of a deceased person.

This means that property that is unrelated to the deceased estate (such as money or assets transferred into the Testamentary Trust by another person after the death of the Willmaker) will generate income that is not exempt from penalty tax rates.  

Furthermore, classes of beneficiaries not included by the deceased in their Will can’t be added later to receive exempt income.

Perhaps most significantly for estate planning, exemptions won’t apply to income generated by property transferred into an existing testamentary Trust (say, created on the death of one parent) when the second parent dies.

Does this mean that I shouldn’t use a Testamentary Trust in my Will?

Probably not. A Testamentary Trust remains one of the most useful structures in estate planning to avoid inadvertent taxation consequences, provide asset protection benefits to your adult beneficiaries (such as a spouse or adult children) in the event of their relationship ending or bankruptcy, and to provide for minor children.

However, if any of the following apply to you, you should consider seeking advice from your estate planning lawyer about whether your Will needs to be updated:

  • My partner and I have minor beneficiaries (such as children or grandchildren) and we have established a Testamentary Trust/s in our Wills to look after them if we die.
  • My partner and I have adult children who have or will have children of their own, and we have established a Testamentary Trust/s in our Wills for our adult children.     
  • My Will establishes a Testamentary trust for my partner, and I also have adult or minor children.

The DDCS wills and estate planning team are highly experienced and specialise in helping people navigate issues like these. To discuss your circumstances, phone our team on (02) 62127600 or fill in the contact us form and our team will be in touch.