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...