Family Trust Elections – Essential Facts & Considerations

Family trust elections (FTEs) are crucial choices made by trustees of family trusts in Australia to unlock tax benefits and avoid significant penalties. These elections establish a trust as a “family trust” for tax purposes, ensuring compliance with Australian taxation laws and creating a framework for permissible distributions. Making an FTE can help access tax concessions, utilise carried-forward tax losses, and avoid penalties such as the family trust distribution tax (FTDT). Below is an overview of the purpose, timing, process, and tax implications of family trust elections.

Purpose of a Family Trust Election

The main objectives of making a family trust election include:

1. Access to Tax Losses and Bad Debt Deductions – An FTE allows family trusts to utilise the previous year’s tax losses and bad debt deductions. This is particularly advantageous for family businesses that have incurred losses in prior years and need to offset these losses against future taxable income.
2. Protection from Family Trust Distribution Tax (FTDT) – Without an FTE, trusts that make distributions outside their designated “family group” may incur FTDT, which is a 47% tax on the distributed income. An FTE reduces the risk of this tax by defining a clear family group and ensuring distributions are made within it.
3. Franking Credit Utilisation – Trusts with FTEs can more easily access franking credits from dividends paid by entities in which the trust holds shares. Without an FTE, a trust might be prevented from using franking credits because it might not meet the “holding period rule” for shares, especially if there are non-family beneficiaries.
4. Streamlined Compliance and Control – FTEs simplify compliance by allowing distributions and capital gains within the family group, which reduces the need for strict tracking of non-family beneficiaries and potential tax liabilities arising from distributions to them.

Timing of a Family Trust Election

The timing of a family trust election is essential because it is usually irrevocable and must be carefully planned to coincide with tax strategy and family succession planning. Important considerations for timing include:

• When Losses or Bad Debts Are Incurred – A family trust should consider making an FTE if it has accumulated losses or bad debts that it wishes to offset against future income. The election should be made before these losses are intended to be used.
• Prior to Distributions Outside the Immediate Family – If a trust anticipates needing to distribute income or capital outside the immediate family members, making an FTE can help ensure these distributions avoid FTDT by defining the scope of the family group.
• Before Claiming Franking Credits – If the trust expects to claim franking credits on dividends received, making an FTE helps satisfy the requirements to access these credits. This should generally be in place prior to receiving substantial dividend income.

Process of Making a Family Trust Election

To make a family trust election, the trustee must complete the relevant election form and file it with the Australian Taxation Office (ATO). Here’s the step-by-step process:

1. Define the Test Individual – The FTE process requires nominating a single individual as the “test individual.” This person is generally the main beneficiary around whom the family group is defined, such as the primary income earner or head of the family. The test individual effectively determines who can be part of the family group.
2. Identify the Family Group – The family group includes the test individual, their spouse, children, grandchildren, siblings, nieces, nephews, and certain other family members. It is important to clearly document who is included to ensure compliance with the FTE’s limitations.
3. Complete and Lodge the Family Trust Election Form – The FTE must be made in writing on the ATO’s approved form, providing details of the trust, the test individual, and the date of the election.
4. Backdating (if Applicable) – A family trust election can be backdated to a previous income year as long as it is lodged within the four-year amendment period allowed by the ATO. This is useful if the trust seeks to retrospectively apply the election to take advantage of past losses or franking credits.

Tax Implications and Compliance Requirements

Once a family trust election is made, the trust must comply with the following requirements:

• Distribution Limits within the Family Group – After an FTE is made, the trust is generally restricted to making distributions within the designated family group. If distributions are made to individuals or entities outside this group, they will be subject to FTDT at the rate of 47%.
• Irrevocability of the Election – Generally, an FTE is irrevocable, meaning that once it is made, the trust cannot reverse it. Trustees should consider the election’s long-term impact on the trust’s operation, succession planning, and family dynamics.
• Interaction with Interposed Entity Elections (IEEs) – If the family trust has investments in companies, partnerships, or other trusts, those entities may also need to make an Interposed Entity Election (IEE) to ensure they are considered part of the family group. An IEE helps prevent FTDT from applying to distributions made to interposed entities within the family structure.

Key Considerations Before Making a Family Trust Election

Before making an FTE, trustees and beneficiaries should consider several important factors:

• Succession and Future Family Needs – Since the FTE is irrevocable, trustees should consider future family changes, such as potential additions to the family group or changes in ownership or control of the trust. This is particularly relevant if future distributions might need to go outside the family group.
• Eligibility for Tax Losses and Franking Credits – Ensure the trust has potential tax losses or franking credits that justify the election. If the trust does not expect to use these benefits, the FTE may not be necessary.
• Impact on Other Beneficiaries – Once an FTE is made, any distributions to individuals or entities outside the family group will attract FTDT. Therefore, trustees must evaluate if the trust needs to retain flexibility to distribute income outside the immediate family.
• Administrative and Compliance Burden – Complying with FTE requirements requires careful management of distributions and tracking of family group members. The administrative responsibilities should be weighed against the potential tax benefits.

Common Scenarios for Family Trust Elections

Some common situations where FTEs are advantageous include:

• Trusts with Substantial Tax Losses – If a trust has significant carried-forward tax losses, an FTE can unlock these losses for offset against future income, potentially lowering taxable income.
• Accessing Franking Credits – Trusts that receive dividend income from shares in Australian companies can use an FTE to simplify access to franking credits, reducing taxable income for beneficiaries within the family group.
• Asset Protection – By making an FTE, trustees can retain greater control over the family’s assets within a defined group, reducing the risk of claims or losses from extended family members or third parties.

Conclusion

Family trust elections are powerful tools for managing the tax and compliance profile of a family trust, especially when utilising losses, claiming franking credits, and ensuring tax-efficient distributions within a family group. However, the irrevocability of the election, potential FTDT penalties for out-of-group distributions, and administrative requirements mean that careful consideration is essential. Trustees should conduct a detailed assessment and consult with their tax adviser before making an FTE to ensure alignment with the family’s tax objectives and long-term needs.