Originally published in the Finanical Review by Sally Patten:
Small business owners will be more likely to establish a discretionary trust to spread their income among family members and avoid paying the top marginal tax rate as a result of the proposed budget changes.
The extent of the proposed gap between the top two personal rates of tax, unveiled in Tuesday's federal budget, will create a greater incentive for individuals to keep income levels to below $200,000, tax advisers said.
Treasurer Josh Frydenberg announced plans to flatten the personal income tax structure, creating a 'mega bracket'.
From 2024-25 individuals earning between $45,000 and $200,000 a year will pay 30 cents in the dollar in tax, while those earning more than $200,000 a year will pay the top rate of tax of 45 percent.
"I think any time you get that sort of jump, people will try hard to save tax. There is good evidence that there is clustering of income levels just below tax thresholds," said Mark Molesworth, a tax partner at BDO in Brisbane.
Family trusts are discretionary trusts that are set up to hold a family’s assets or to conduct a family business and can reduce household tax bills by ensuring all family members utilise their income tax- free thresholds. By July 1, 2024, people on incomes of $200,000 will receive $11,640 in annual tax savings, the budget papers showed.
Sean Cortis, chief executive of financial advice firm Chapman Eastway, said that if a business owned by a couple was earning more than $200,000 in taxable income a year, it would make sense to split that income between the two partners by running it through a family trust. The trust could distribute the income between the beneficiaries, who would pay tax at their new 30 per cent marginal rate.
If the business was generating more than $400,000 a year, the income could be distributed to other trust beneficiaries over the age of 18, who also would pay 30 per cent tax on income of less than $200,000 a year.
‘‘The lowering of the tax rate [from 32.5 per cent and 37 per cent] provides more of an incentive to do this,’’ Mr Cortis said. Brett Evans, managing director of Atlas Wealth Management, argued that businesses planning to grow would have a greater incentive to use discretionary trusts because the savings would be greater on larger profits, justifying the costs of running the vehicle. Family trusts cost about $2000 a year to run.
‘‘They will definitely become more popular,’’ he said. Conversely, advisers said that businesses generating profits of less than $200,000 a year might be less inclined to use a family trust because they may prefer to take advantage of the proposed simplified tax system, which will comprise four, rather than five tax brackets. Mr Cortis predicted the proposed 30 per cent mega tax bracket would also encourage more private companies to distribute excess profits via dividend payments because of the reduced tax impost on shareholders.
Mr Molesworth warned individuals against going to extreme lengths to remain under the 30 per cent tax threshold. He said it was possible some people earning more than $200,000 a year would look to negatively gear property or take out margin loans to gear shares to reduce taxable income. But, he said: "You always have to look for what will make up the loss."
Individuals would need to be confident that any property or shares purchased produced a capital gain. Mr Molesworth added: ‘‘You are spending 100 cents to save 15 cents in the dollar. You have got to think about the losses. There has got to be a commercial reason [to minimise tax] otherwise you are just losing money.’’ Mr Evans argued that maximising pre-tax superannuation contributions would become more important for individuals earning just over $200,000 a year.