Example of asset protection with a discretionary trust

Hopefully the concept of how to utilise trust distributions in my last post was clear and the characters in the example were not too distracting.

By the way if the ATO ever asks you why you have a discretionary trust, please remember not to say for the tax savings; instead mention asset protection and give an example similar to below. (There is a law that prohibits us from doing things just for the tax benefits which is funny because coming to see me can make you a criminal.)

Asset protection

 

Let's say that Sheldon will always be Sheldon so he is always getting into trouble due to his social awkwardness.

And Amy is normal for our intent and purposes despite being one of the few people in the world who can fall in love with Sheldon.

So this couple have been together for a while and have a huge pool of savings so decide that they should invest together as they plan for their future. Amy rejects Sheldon's suggestion of investing in a nuclear fusion plant but compromises and thinks that an investment property would suit them nicely.

Now Amy is worried that Sheldon is a ticking time bomb and will eventually get sued by someone for his reckless antics and outbursts even though he believes that he is always right. For this reason Amy suggests that their investment is purchased solely under her own name.

However Sheldon is a control freak and wants a legally enforced say in the decision making regarding their investment. Since he knows everything, he suggests that the investment is purchased with a discretionary trust where they are joint trustees so that they share the decision-making. This way Sheldon has shared control over the property and can receive the benefits of it such as rental income by naming himself as a beneficiary, but the property is not owned by him. Therefore it will not be listed as his asset if he ever faces personal bankruptcy.

Amy loves this idea and has to comfort Shelden when she tells him that Spock from Star Trek cannot be listed as a beneficiary since he is a fictional character. Let me know if you would like more information about this example of asset protection using discretionary trusts. In the meantime, live long and prosper!

Example of strategically distributing income with a discretionary trust

I decided to have some fun and use the cast of The Big Bang Theory to give some examples of how the general advantages of discretionary trusts could help in their situation. See if any of these examples could apply to you.

Income distribution

Let's assume that Penny will always work at the Cheesecake Factory for minimum wage and unfortunately never makes it big in Hollywood.

And let's say that in his spare time when he is not working at the university, Leonard invents some sort of new laser which he sells around the world.

Now before he embarked on this laser venture, he created a discretionary trust to run this very business. Luckily he did so, otherwise the profits from his laser business would be taxed in his own name on top of his salary from the university which would probably propel him up a tax bracket or two. (This is because in Australia we have a progressive tax system where the more you earn, the higher rate of tax you pay. Um Australia? Yes, let's assume that everyone in the series also moved to Adelaide.)

Leonard's accountant notices that Penny's tax return shows very little income from her wages and advises Leonard that his trust could distribute the laser business profits to Penny instead of him since she is in a much lower tax bracket. Penny agrees as long as Leonard pays her tax bill and takes her out to a movie which is not a documentary or a sci-fi. Leonard is happy to do so since his tax savings far outweigh a couple of movie tickets and popcorn. Everyone is happy. Cue the theme song with credits.

These illegally-obtained pictures take up quite a bit of space so I might split these up to one example per post. Stay tuned for another example of how discretionary trusts could help you and let me know if you have any questions or want more details.

Business structures: Should I run my business with a discretionary trust?

A while ago I highlighted some of the main advantages and disadvantages of running your business under your own name and my last post outlined the basics of how a discretionary trust works. The next question you will probably ask is 'should I run my business with a discretionary trust?'

These are the general advantages and disadvantages of using a discretionary trust to run your business:

Advantages

• Income distribution
  Every year the profits of the trust can be distributed to whomever the trustee decides which means your accountant can help you utilise the lower tax brackets of family members, offset tax losses in your other trusts and companies or limit your tax to the corporate tax rate by distributing to a company.
   
• Capital gains tax discount
  When you sell an asset that you held in your own name for more than 12 months such as shares or a rental property, the ATO allows us to disregard 50% of the capital gain. When a trust sells a similar asset or when it eventually sell your business, then beneficiaries who are individual tax payers also get to utilise this 50% discount when the profits of the business sale are distributed to them.
   
• Asset protection
  As the trustee is holding property for the benefit of the beneficiaries, it does not own the trust assets so there is a division of assets between the trust assets and what the trustee owns in their own name. You could also separate each of your assets into different trusts so that if any one of them face something disastrous such as bankruptcy, then your other trusts with their respective assets will generally not be involved and can continue as usual.

Disadvantages

• Costs to setup and maintain
  Not only are there the obvious legal costs to create the trust deed and accounting fees for the annual tax return and reporting requirements, there is also the investment of your time to learn how to best utilise the benefits of your discretionary trust.
   
• Changes to trust law and legislation
  Over the last few years, the ATO has been increasing their focus on discretionary trusts and are trying to make these trusts look less desirable for business owners or investors. Some examples are there are more items to fill out on trust tax returns now than before; there are penalties for some trusts who distribute profits to companies; and children previously could each receive $3,666 of tax free trust distributions but now can only receive $416 each.

There is a lot to digest in this post and they are generalisations so please contact me to discuss how a discretionary trust would work in your own situation. Actually I had an idea watching a sitcom last night so in my next post I'll assume CBS don't mind and give some examples of the advantages of a discretionary trust using the characters of...

What is a family trust?

When someone says family trust, they are probably referring to a discretionary trust. The main reason why the word family usually replaces discretionary (besides being a shorter word) is probably because the trust is intended to benefit themselves and their own family members. There really is such a thing as a Family Trust though so I might come back to this in a later post.

So what is a trust?
Essentially it is a relationship where a trustee holds onto assets on behalf of one or more beneficiaries.

What is a trustee?
A trustee is whoever has control over the trust assets and is required to make decisions and attend to the day to day running of the trust. Think of the trustee as the manager of the assets, but technically not the owner. A company can act as a trustee so the decisions then rest on the director(s) of the company.

What is a beneficiary?
A beneficiary is the real owner of the trust even though they don't necessarily make any decisions and some beneficiaries don't even know that the trust exists. Beneficiaries are entitled to the assets of the trust and any profits generated from those assets. Most trust deeds allow other trusts and companies to be beneficiaries as well.

What is a trust deed?
A trust deed is the legal document that outlines the terms and conditions of the trust such as how it is to be setup and then how it is to be run. The trust deed will also specify who the appointor is.

What is an appointor?
The appointor has the important power to be able remove or replace trustees. This is usually the limit of their influence as appointors are not involved in the day to day running of the trust. However the appointor can also be the trustee if they so choose.

What is so discretionary about a discretionary trust?
Under current Australian taxation law, if a trust makes a net profit then it normally should distribute this profit to its beneficiaries every financial year. This is when the trustee can exercise their discretion to decide which beneficiaries will receive how much of the profits every year. Some years a beneficiary will receive more than last time, or less, or none at all. Sometimes the trustee can decide to not pay out any profits at all if they so decide.

Now you all know the bare basics of a discretionary trust. And I'll know that you don't read my blog if you keep referring to a family trust instead of a discretionary trust! Next time I will go through some advantages and disadvantages of using one to run your

2013 election promises

Public service announcement: Remember to vote this Saturday!

I missed voting in one election before and got a fine for it. It felt great having to pay for not exercising one of my constitutional rights. Anyway I'm going to list some of the relevant tax and small business election promises that both Liberal and Labor are making so that we can refer back here later to see how many were broken.

Labor

• Reduce GST reporting requirements from quarterly to annual.
  (This is nice but you all better still reconcile your bank accounts regularly.)
   
• Temporarily increase new asset purchase write-off from $6,500 to $10,000 until 30 June 2015.
  (Sounds nice but the existing $6,500 limit covered most things already.)
   
• Committed to delivering the National Broadband Network (NBN).
  (This isn't new but they keep going on about it; probably because it cost so much. Well I hope you guys live in one of those roll-out areas because it's not even planned for my suburb yet.)
   
• Continue the company tax loss carry-back scheme and expand the carry back period to two years as planned.
  (I think the original intention of this was to save companies who have a bad year from going bankrupt but if your company has to rely on tax relief to survive then you really are just delaying the inevitable. Reminds me of the Australian car manufacturing industry.)
   
• Continue with not allowing the statutory formula for motor vehicle fringe benefits tax.
   (Apparently this will generate more tax revenue for the government but if employers stop buying cars then there will be nothing to tax. Now who is going to pay that $200 million package promised to the car manufacturing industry?)

Liberal

• Abolish the carbon tax.
  (Bit late now since I doubt prices will come down for things like electricity and freight costs.)
   
• Reduce company tax rate to 28.5% from 1 July 2015.
  (This is very nice. The resulting franking account reduction should be negligible for most of us.)
   
• Delay the compulsory superannuation guarantee increases.
  (Well good if you're the employer and bad if you're the employee.)
   
• Abolish the mining tax.
  (Olympic Dam expansion might then go ahead after all.)
   
• Discontinue the $6,500 new asset purchase write-off and $5,000 accelerated depreciation for motor vehicles.
  (This is disappointing. That Labor policy of increasing the write-off is looking pretty good now.)
   
• Discontinue the company tax loss carry-back scheme.
  (Hopefully none of us need to use this.)
   
• Reinstate the statutory formula for motor vehicle fringe benefits tax.
  (You all might as well finish off those log books since we can use them for five years anyway.)
   

I'll keep adding to this post as I find things during the week. Remember to do your own digging around before you vote as these are my own opinions only. Hope all the dads out there had a

My apology for the slow responses recently

Ok I'm back! Earlier this month I had the worst stomach virus that I can remember and unfortunately it was right in the middle of the busiest time of year for me so I'm still scrambling to catch up. It was so painful that I self-diagnosed myself with the medieval disease of dysentery. People who know what it is just roll their eyes at me but if you need to use the word explosive to describe both your bowel movements and headaches then surely I'm on the right track.

Firstly apologies to everyone whose meetings I had to postpone. So far I haven't found anyone who got as sick as I did so you're all welcome for my self-imposed quarantine. I've also since disinfected my house so feel free to visit now although the hospital smell is gone if you're into that sort of thing.

I'll keep this one short since I still have dozens of emails and Facebook messages to reply to. Now I did have some time to think in between my constant toilet breaks and fever induced naps, and I realised how little we look after our most important asset - which is ourselves.

For example, some of us look after our cars really well with regular services and swear by certain brand name premium fuels. Yet do we take ourselves to a doctor for an annual checkup and eat the very best organic foods?

Here's an example I am guilty of: I make sure that my computer is always free of junk, all files and folders are neat and regularly backed up, and a virus scanner ensures that nasties are kept away. But my fridge and pantry is stocked with junk, the only thing backed up is when I go to the toilet, and evidently my immune system just couldn't cope with all the nasties and decided to shut me down for an emergency detox.

So I kindly ask that you all help me fix this. If you see that I have a can of soft drink on my desk instead of a glass of water, then slap me. If you see McDonald's or KFC wrappings in my trash, then slap me. Perhaps then I'll wake up and take better care of the most integral part of my business. And hopefully this has made you all think of your own health and well being too.

Quick summary of WorkCover in South Australia

I have been helping out with quite a few annual reconciliation statements so I might as well write about it since it's on my mind.

What is WorkCoverSA?
WorkCoverSA is the organisation that manages the South Australian Workers Rehabilitation and Compensation Scheme. They do a quite a few important things such as help people recover but basically they provide insurance for employees who are injured at work.

Ok, it's insurance for employees. Who pays the insurance premiums?
Employers pay the premium. The premium is calculated as a percentage of the total remuneration paid to your employees.

What is remuneration?
Remuneration is defined as payments made for the benefit of your employees. Besides salary and wages, remuneration includes their superannuation, bonuses, allowances and many others. The full list can be found here but it is updated every year so make sure to check before preparing your annual reconciliation statements.

What is the annual reconciliation statement?
Most employers can pay their premium in ten monthly instalments rather than an annual lump sum which helps with cash flow. However since your payroll will most likely change during the year, at the end of the financial year you need to recalculate your WorkCover premium and pay (or get refunded) the difference between your instalments already paid.

What are the key dates?

• Your annual reconciliation statement is due by 31 July. (If you pay your premium as an annual lump sum then it is due now as well.)
• Then any shortfall payments or refunds resulting from the reconciliation should be settled by the end of August.
• If you pay your premium in instalments, then the ten monthly payments start on 7 September and end on 7 June each financial year.

For more information on how your premium is calculated, please visit the WorkCover SA website here which tries to explain how they came up with your rate. If you have any questions about WorkCover or workplace injuries then feel free to contact me for more information. Even they believe we are Better together!