Family trusts have many advantages, one of these being the ability to distribute business profits to your children. This is a popular strategy which can be used to reduce your overall tax liabilities at year end. Under trust law however there is an often overlooked problem in that your children have a legal right to demand that the trust physically pay those distributions to them. Using the following example to demonstrate the potential problems, there are some issues that you need to be aware of:
John and Susan Baker own and operate a successful air-conditioning installation business. To save considerable tax, John and Susan are distributing some of their business profits to their 2 children, Liam aged 22 and Carter aged 19. Below are three issues John and Susan need to consider when using this strategy:
- If we have allocated $80,000 to Liam and $70,000 to Carter this year – how would the trust find the cash to fund these distributions if it was ever necessary to pay them out. Most children do not ask for the money but if we allocate $80k to Liam in each of the next five years that may be $400k that one day he could demand from the trust.
- The second issue is family law – should the children ever find themselves the subject of a family law action, their partner may have an entitlement from the trust and this will be included in the asset breakup.
- Estate planning is the third issue as there is an entitlement (ie. asset) existing when someone dies that needs to be dealt with under that persons will. There is a myriad of estate planning issues to be considered…should the children be in a long term relationship, this may mean that their partner would be entitled to the loan account entitlement. Having the trust pay out $400k to a defacto partner indicates the importance of addressing this matter now. What would happen if Liam or Carter died without a will. If John and Susan are tragically killed what would happen? Could Liam being the oldest, take control of the business and pay out his loan account leaving no cash or means to pay out Carter!
In order to mitigate these issues, careful consideration and planning are required. If you have not thought through these issues, please call the office on 03 8393 1000 and speak to me about your situation.
Steve Wildes, Partner, Paris Financial
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