Avoiding the 47% Family Trust Distribution Tax Trap
Family trusts offer powerful tax planning benefits for Australian families but only if used correctly. A simple mistake in how you distribute trust income can trigger a hefty 47% tax on that income, wiping out the very tax savings you intended. This punitive impost is known as the Family Trust Distribution Tax (FTDT) which is essentially a tax trap awaiting trustees who pay trust distributions to the wrong people.
In this article, we explain how to steer clear of the 47% FTDT trap. We’ll break down what FTDT is under the latest ATO guidance, why family trusts are useful, how they reduce tax, common pitfalls in trust distributions, who counts as “family” for trust purposes, and practical steps for trustees to avoid costly mistakes. Business owners, trustees, and family groups, read on to protect your trust’s benefits and stay on the right side of the tax law.
What is the Family Trust Distribution Tax (FTDT)?
Family Trust Distribution Tax is a special tax applied at the top marginal rate (currently 47%, including Medicare levy) when certain trust distributions are made to people outside a defined “family group.” In simple terms, it’s a penalty tax designed to prevent family trusts from distributing income to outsiders.
If a family trust (one that has made a valid Family Trust Election) distributes income or capital to anyone not in its nominated family group, the trustee becomes liable to pay FTDT on that amount. Importantly, the tax is a flat 47% on the distribution regardless of the recipient’s personal tax situation and it’s payable by the trustee to the ATO.
FTDT is often called a 47% tax trap because once it’s triggered, there is no discretion for the ATO to waive or reduce it. Even if the distribution was made by mistake or due to changed circumstances, the Commissioner cannot ignore the tax or grant any leniency.
This makes it crucial for trustees to clearly understand who is (and isn’t) in the trust’s family group before making distributions. FTDT applies on top of any normal income tax that might be due, effectively negating any tax advantage of the distribution. The bottom line: to avoid the 47% FTDT, you must keep trust distributions within your allowed family group at all times.
Family Trust Elections and the Family Group, Who’s Inside vs Outside?
Not every trust with “Family” in its name automatically gets the tax advantages of a family trust. To be a family trust for tax purposes, the trustee must formally lodge a Family Trust Election (FTE) with the ATO, naming one person as the “specified individual.” That person’s extended family then becomes the trust’s “family group” for tax purposes.
Once an FTE is in place, a strict definition of family group applies and any distribution outside that group will incur the 47% FTDT. This is the trade-off: by electing, you unlock certain tax concessions (more on these below), but you also accept limits on who can receive distributions.
Who is in the family group? Typically it includes the specified individual and their close relatives by blood or marriage. For example, the individual’s spouse, their children and grandchildren (including adopted or step-children), their parents and grandparents, their siblings, and any nieces and nephews (plus the spouses of all those people) are all within the family group.
In essence, it’s a wide circle of immediate family across generations. In addition, any trust, company or partnership in which those family members collectively own 100% of the interests can be brought into the group (often by making an Interposed Entity Election (IEE) for that entity).
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Who is outside the group? Anyone not fitting the above categories is considered an outsider for FTDT. This could be more distant relatives (like cousins), unrelated friends or business partners, or any entity not wholly owned by the family. A distribution to any such outsider will trigger the 47% tax.
For instance, if your trust distributes income to a company that has even one outside shareholder, the trustee will owe 47% FTDT on that payment. (Remember: even if your trust deed names someone as a beneficiary, they must also fall within the family group if an FTE is in force the tax law’s family-group test overrides the deed.)
Why make an FTE? Given these restrictions, why bother electing? Because being a family trust comes with valuable tax benefits for closely held groups. Key perks include easier use of trust tax losses, access to certain company loss concessions for shareholdings, full use of franking credits on dividends, exemption from some trust reporting requirements, and smoother application of small business CGT roll-overs within the family.
In short, if you plan to keep distributions in the family, an FTE can greatly enhance the trust’s tax effectiveness. Many family businesses make the election for these advantages they gain flexibility and tax relief, and in return they simply refrain from distributing outside the family group.
Once a family trust election is made, it remains in force indefinitely (unless revoked in rare circumstances). The specified individual can only be changed in very limited cases. That means you should choose the “test individual” carefully and plan long-term. It’s also vital to monitor your family group over time. If family dynamics or ownership structures change (through marriage, divorce, new entities, etc.), ensure your distributions still stay within the allowed group. The ATO warns that many FTDT issues arise because trustees fail to keep track of such changes. Regularly reviewing who is in your family group and what elections are in place is critical to avoid accidental breaches.
Why Do I Need a Family Trust?
A family trust (typically a discretionary trust) is a popular structure for business owners and investors because it offers a mix of tax effectiveness, control, and asset protection. Key benefits include:
Tax Planning & Income Splitting: The discretionary nature of a family trust allows you to distribute income in whatever way best minimises the overall tax for your family. Profits can be split among family members so that more income is taxed in the hands of those with lower tax rates, instead of all in one person’s higher bracket. This flexibility to allocate income each year underpins the significant tax savings that trusts can provide (within the bounds of the tax law).
Asset Protection: Assets held in a discretionary family trust are not owned personally by any one beneficiary. They are legally owned by the trustee on behalf of the family. This separation means that if an individual family member encounters financial trouble (say, lawsuits or creditors), the assets in the trust are generally safer from those personal liabilities. In essence, the family’s wealth is shielded within the trust structure.
Succession & Estate Planning: A trust provides a built-in mechanism to pass wealth to the next generation in a controlled manner. Unlike an individual, a trust can continue operating for many years (often decades), so it can hold and manage family assets even as leadership shifts from one generation to the next. You can set up rules or appoint successor trustees to ensure the trust assets and business interests are managed according to the family’s wishes over the long term, without the need for probate or estate transfers upon each person’s death.
In summary, you might consider a family trust if you have a family-run business or investments and you want to maximise tax efficiency and protect assets for your family unit. While there are costs and administrative responsibilities involved in maintaining a trust (initial setup, annual filings, compliance with distribution rules), the benefits in tax savings, asset security, and flexibility often make it a worthwhile vehicle for family wealth management.
How Can a Trust Help Reduce Tax?
A major reason to use a family trust is to legally reduce the overall tax your family pays. Here are some key ways trusts achieve this:
Income Splitting: A discretionary trust allows the trustee to distribute income across multiple family members in whatever proportions best reduce tax. More income is allocated to relatives in lower tax brackets, and less to those in higher brackets. Because Australia’s tax rates rise with income, splitting a given profit among (for example) three people will usually result in much less total tax than having one person declare it all. For instance, one individual receiving $200,000 of trust profit might incur around $60k in tax, whereas if three family members receive about $67k each, the combined tax might drop to roughly $40k – saving the family approximately $20k. (Using family members with little or no other income is especially effective, as the first $18,200 each receives can be entirely tax-free under their threshold.) Each beneficiary does pay tax on their share, but if structured well, the overall tax rate on the trust’s income is much lower than if it were all taxed in one person’s hands.
Using a Company Beneficiary (“Bucket Company”): Another strategy is to distribute some trust income to a family-owned company to cap the tax rate. Companies pay a flat tax (around 30%), which is below the top personal rate. By directing surplus income to a “bucket company” within the family group, that portion of income is taxed at 30% instead of 47%. (It’s crucial that any company beneficiary is actually within the family group often achieved by filing an IEE otherwise the distribution would trigger FTDT.)
Capital Gains and the 50% CGT Discount: Trusts have an edge over companies for capital gains because trusts can access the 50% CGT discount that individuals enjoy. If the trust sells a long-term asset at a profit, only half the gain is taxable when passed to individual beneficiaries. For example, a $100,000 capital gain made by the trust can be distributed to an individual such that about $50,000 is subject to tax (after the 50% discount). In contrast, a company would pay tax on the full $100k gain (since companies don’t get the discount). By routing capital gains to individual beneficiaries, a trust helps the family significantly cut the tax on one-off windfalls. (Note: if a trust distributes a capital gain to a company beneficiary, the 50% discount is lost so usually capital gains are not allocated to companies.)
Selective Streaming of Income Types: If the trust deed permits, the trustee can “stream” specific types of income to different beneficiaries to maximise tax benefits. For instance, if the trust’s income includes both franked dividends and rent, the trustee might allocate more of the franked dividends to a beneficiary who can fully utilise the franking credits (say someone with low taxable income who could even get a credit refund), while allocating more of the rental income to another beneficiary. This way, each category of income lands with the family member best positioned to take advantage of its tax attributes.
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What are the Risks of Trust Distributions?
Even with the best intentions, trustees can stumble into expensive mistakes. Common pitfalls include:
Missing the 30 June deadline: If you don’t finalise your trust’s distribution by the end of the financial year (30 June), any income left undistributed will be assessed to the trustee at 47%. In short, failing to make a valid distribution resolution on time means the ATO taxes the trust’s income at the top rate by default.
Disallowed beneficiaries (outside scope): Only distribute to people or entities who are allowed by your trust deed and (if you have an FTE) who fall within the family group. If you distribute to someone not permitted by the deed, or to an “outsider” relative beyond the family group, that income will effectively be taxed at 47% either because the distribution isn’t recognised (and the trustee gets taxed) or because FTDT applies. Always double-check your deed and family group list before distributing.
Minors or non-residents: Distributions to children under 18 or to non-resident beneficiaries generally don’t provide tax savings. Minors’ unearned income above a low threshold is taxed at punitive rates (approaching 45–66%), and non-residents are subject to withholding tax (often at the highest rate) on trust distributions. In other words, these beneficiaries can attract nearly the same top tax rate, eliminating any advantage.
Artificial schemes and Section 100A: Avoid arrangements that attempt to exploit trust distributions in contrived ways. For example, don’t allocate income to a low-tax beneficiary (like an adult child) with the intention of secretly funneling the money to someone else in a higher bracket. The ATO’s anti-avoidance rules (such as Section 100A) can deem such distributions invalid and make the trustee pay tax at 47% instead. Distributions should reflect a genuine benefit to the actual beneficiaries.
Poor records or forgotten elections: Inadequate record-keeping or not keeping tabs on your trust’s elections can lead to accidental breaches. Many FTDT incidents occur simply because a trustee forgot that a Family Trust Election was in place or didn’t realize a beneficiary had ceased to be in the family group. Always maintain clear documentation (trust minutes, beneficiary lists, election notices) and review them regularly. Good governance and annual reviews help ensure you don’t accidentally violate the rules.
How to Avoid the 47% Tax Trap: Trustee Obligations and Best Practices
To fully enjoy your family trust’s benefits while steering clear of traps, follow these best practices:
Know Your Trust Deed (and Income Definition): Make sure you understand your trust deed’s provisions especially who can be beneficiaries and how “trust income” is defined. All distributions must comply with the deed’s terms. If you don’t follow the deed (for example, distributing to someone not permitted, or miscalculating income per the deed’s definition), the distribution could be invalid or subject to penalty tax.
Plan Beneficiaries Before Year-End: Don’t wait until the last minute. Well before 30 June, decide who will receive the trust’s income and confirm they are eligible beneficiaries (per the deed and any family trust election). This early planning gives you time to address any issues and avoid scrambling or errors on June 30.
Make Timely (30 June) Resolutions: By law, the trustee’s distribution decisions must be documented by 30 June each year. Always sign a valid distribution resolution on or before that date, allocating all net income to the chosen beneficiaries. This ensures no income is left undistributed (which would otherwise be taxed to the trust at 47%) and that the ATO will recognise your intended allocations.
Monitor FTEs and IEEs: Keep copies of any Family Trust Election and Interposed Entity Elections, and review them annually. Be mindful of changes in your family or business structure that could affect who is in the family group (new entities, marriages, divorces, etc.). The ATO specifically recommends reviewing these elections each year. Staying aware of your elections and family group membership will prevent accidental out-of-group distributions.
Never Distribute Outside the Family Group: If you have an FTE in place, do not distribute trust income to anyone outside the specified individual’s family group, no exceptions. Even a well-intentioned distribution to a non-family member will incur the 47% tax, and the Commissioner has no discretion to waive it. If someone outside the group needs to be rewarded or assisted, do it from personal funds (after-tax), not via a trust distribution.
Maintain Clear Records: Good record-keeping is a trustee’s friend. Keep thorough documentation of your trust’s activities, minutes of meetings, annual distribution resolutions, beneficiary lists, election notices, etc. Organised records make it easy to demonstrate compliance and help you avoid mistakes. For example, having past resolutions and election documents on hand will remind you of which elections are in force and who your beneficiaries are.
Stay Informed on Trust Rules: Tax laws and ATO policies evolve, so keep up with any updates regarding trusts. Watch for ATO bulletins or guidelines about trust distributions and compliance. If the ATO flags certain trust practices as risky or unacceptable, take heed and review whether your trust is affected. Being informed means you can adjust your strategies proactively and remain on the right side of the law.
Seek Professional Advice When Unsure: Finally, if you’re ever uncertain about a complex trust issue or unusual scenario, consult a qualified tax professional or advisor. This includes situations like varying an FTE, dealing with non-standard distributions, or reorganising a family business involving the trust. Trust law is complex and the stakes are high. Getting expert advice can save you from costly missteps.
Leverage Your Family Trust Safely and Get Expert Help if Needed
Used correctly, family trusts are a powerful vehicle for protecting wealth and minimising tax within a family. The key is to stay vigilant and abide by the rules seemingly small oversights can lead to outsized tax consequences. By understanding the 47% FTDT trap and following best practices, you can ensure your trust continues to deliver its intended benefits without unwanted surprises from the ATO.
That said, trust law is intricate and the stakes are high. If you’re ever unsure about your trust’s compliance or want to optimise its performance, seeking expert guidance is wise. Cordner Advisory specialises in helping business owners and family groups navigate the complexities of trusts and taxation. Whether it’s setting up a new family trust, making or managing a Family Trust Election, or reviewing your distribution strategy, our team can provide tailored advice to keep you on track.
Contact Cordner Advisory today to discuss your family trust needs, we’ll help you implement best practices, avoid the common traps, and ensure that your trust works for you, not against you.
