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Missing trust distributions can cost you a lot of money.
Missing Trust Distributions
At first, all seems lost when you have missing trust distributions. But not necessarily. In this episode, Geoff Stein of Brown Wright Stein Lawyers in Sydney will walk you through the options you have.
Here is what we learned but please listen in as Geoff explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Missing Trust Distributions
Imagine you have a new client – a discretionary trust with regular income. Looks all fine. And then you ask for the latest distribution resolution and receive blank stares. What resolution?
As it turns out, the trustee never made any resolutions. EVER. Right from the start. The trust was established many years ago and nobody ever paid any tax on the income. What do you do?
What Should Have Happened
Here is how it works. A trust doesn’t pay any tax. The beneficiaries do. But for that the trustee needs to distribute the income to them before year-end.
So the trustee does just that. A quick resolution before year-end, saying X gets 100% of the income and Y gets all of the capital gain. Something like that.
And then X and Y include this income in their individual tax returns. This is how it should work.
What Really Happened
But this is not how it was done. The trustee didn’t distribute the income. So – in theory – the trustee ends up with the income. The trustee includes the income in their tax return and pays tax at the top marginal rate.
Top marginal tax rate. Think 45% plus 2% Medicare if the trustee is an individual.
What Do You Do
So you have a problem. There is no resolution to distribute the income. But you also don’t want the trustee to pay top marginal tax rates. What do you do?
You have five ways out of this. Two of them illegal, so not recommended.
1 – Default Beneficiary
The default beneficiary in the deed is your saving grace to get out of this mess. If the deed lists a default beneficiary, all is well. The income automatically got assigned to them the moment the trustee failed to sign a resolution by midnight 30 June.
Let’s hope the payments over the years went to the default beneficiary. If the payments went to somebody else – not the default beneficiary – then of course you have another problem on your hands. The default beneficiary won’t be happy to pay tax on income they didn’t receive. But that is a topic for another day.
So if you have a default beneficiary (who is also the payee), then you just distribute the trust income to their individual tax returns, possibly with an amendment.
2 – Outside the Amendment Period
The amendment period is usually two years for individual tax returns. After that, your tax return is locked in. Neither you nor the ATO can re-open and revisit, unless of course there is fraud or evasion or unless you ask for an exception.
The amendment period can work against you, but also big time for you. And in this case, it very much might work in your (or your client’s) favour.
If the amendment period is already past, you can’t amend anymore. So that means even if you wanted to declare this extra income the default beneficiary received over all those years – you can’t.
The default beneficiary should have included the trust distributions in his assessable income but he didn’t because he didn’t know and now the amendment period has passed. So no need to amend.
The result is that the default beneficiary only needs to include the trust income of the past two or three years in his individual tax return. The rest falls through the cracks.
3 – Assessed to the Trustee
If the deed has no default beneficiary and there is no resolution, then the income is assessed to the trustee. If the trustee hasn’t lodged income tax returns for those years (and they usually don’t), then the amendment period never started and hence never ended.
The same applies if the trustee lodged No Return Necessary (NRN) notices. NRN doesn’t start the amendment period.
So the Get-Out-Of-Jail card the default beneficiary got because he is out of the amendment period doesn’t work for the trustee.
So all income is assessed to the trustee at top marginal tax rates and they need to lodge tax returns for all those past years.
4 – Finding the Resolutions
Your client might suddenly miraculously find the resolutions for the missing trust distributions. No income assessed to the trustee. All assessed to the beneficiary and possibly outside of amendment periods.
Just make sure you don’t see any indications of backdating. Backdating is a criminal offence.
5 – Finding an Updated Trust Deed
Or your client might miraculously find an updated trust deed that lists a default beneficiary. So all income is assessed to the default beneficiary and possibly outside of amendment periods.
Just like before, forging a document is fraud and a criminal offense.
So these are five scenarios to deal with missing trust distributions. But this is just a short summary of our understanding. Please listen in since Geoff Stein explains all this much better than we ever could.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 09 November 2021
Tax Talks spoke to Geoff Stein - Partner at Brown Wright Stein Lawyers - for more details.
