What happens to family trusts on divorce?

A family trust is a good way to minimise tax, by splitting the income and capital gains between family members. However, in a family law dispute, this can create unexpected results.

When a family trust earns income or capital gains, they are divided between the beneficiaries, on the advice of the accountant, to minimise tax. It is the beneficiaries who pay tax, not the trust. For example, if a family member has a small taxable income, the income of the trust can be distributed to that family member, to take advantage of their low tax rate.

The children then end up with a loan account, showing that they are owed money by the trust. If there is a dispute in the family, this can end in disaster.

We represented a husband in a family law dispute. He ran his business through a family trust. For many years, the trust income had been divided between the family members, depending on who had the lowest income.

When the children were studying, they were adults, but had little income. It made sense to distribute substantial trust income to them, as they were in a low tax bracket.

As is normal, this was just a book entry, and no money changed hands. The income was allocated to the children, then recorded in the books as a loan from the children back to the trust. The accountant handled it all, and our client gave it little attention. These loans built up over the years.

In the family law dispute, the adult sons took their mother’s side. The sons demanded payment of the money the trust owed them. The father, who controlled the trust, had no choice but to pay.

The solution would have been for the children to have signed a simple agreement each year to forgive the debts owed to them by the trust. Better still, they could have assigned the debts to the parents. This should have been done every year or two. If you leave it too late, and the children may not agree to sign, there is nothing to do but pay them.

If you know someone who may need assistance, contact our Family Law Specialist Alison Brown or phone us on (02) 9923 2321.