Last week, Treasury released its consultation paper on the proposed 30% minimum tax on discretionary trusts. It runs to 17 discussion questions and gives the country three weeks to respond, which tells you something about how settled the design really is.
But inside the detail is confirmation of something many families have been anxious about since Budget night. The intended direction is now clear: income from genuine discretionary testamentary trusts will be exempt, subject to two proposed conditions.
Good news, with a catch. Two catches, actually.
The proposed tax
In the May Budget, the Government proposed that from 1 July 2028, trustees of discretionary trusts will pay a minimum tax of 30% on the trust's taxable income.
Beneficiaries other than companies will generally receive a non-refundable offset for their share of the tax paid by the trustee. They remain assessed under the ordinary rules. If their income-tax liability exceeds the offset, they pay the balance. If it is lower, the unused offset is lost. It cannot be refunded, carried forward or used against the Medicare levy. It is a floor, not a ceiling.
The target of the measure is income splitting: directing trust income to beneficiaries on low tax rates so the family pays less overall than if one person had earned all of the income directly. Treasury's own example involves a trust splitting $200,000 four ways and saving about $35,000 in tax.
There is no grandfathering. Existing family trusts are caught.
The Budget proposed to exclude income from assets of testamentary trusts already in existence on Budget night.
A testamentary trust explained
A testamentary trust is a trust written into a person's will. It does not exist while they are alive. It comes into existence when they die, at which point the executor moves the inheritance into the trust rather than handing it to the beneficiaries directly.
Their value has made them the cornerstone of modern estate planning. Families use them for three main reasons.
- Protection: assets held in a properly designed testamentary trust may be better protected from a beneficiary's bankruptcy, business and creditor risks than assets inherited outright. They may also offer protection following relationship breakdown, although the family-law outcome depends heavily on the terms of the trust, who controls it and the particular circumstances. The same structure protects beneficiaries who cannot safely manage a lump sum themselves, whether through disability, addiction, mental illness or vulnerability to the people around them.
- Flexibility: the trustee can distribute income and capital among family members as circumstances change over decades.
- And tax: minor children can be taxed at ordinary adult rates, rather than at the penalty rates generally applying to unearned income received by minors. This means up to $22,866 can potentially be distributed to a minor child tax free every year. Compound that. A testamentary trust benefiting three grandchildren with no other income can distribute close to $69,000 a year with no tax paid by anyone, year after year, through their entire childhoods. There is no other structure in Australian tax law that does this, and Parliament built it on purpose.
That concession has a logic to it. A child receiving income from a testamentary trust is often a child whose parent or grandparent has died. Parliament decided long ago that children should not pay penalty rates on the income that replaced their provider.
Published ATO-based estimates put the number of active testamentary trusts at a little over 10,000, roughly 1% of the trusts operating in Australia. But that figure says nothing about the much larger number sitting in wills, not yet born.
Those trusts are unknowable because they remain invisible until someone dies. And since they do not exist until death, none of those future trusts were "existing at announcement".
Under the Budget wording, every one of them would have been caught. A trust created to manage a dead parent's estate for their children was to be taxed as if it were an income-splitting scheme run by the living.
You can see the problem. Eventually, so did the Government.
The testamentary trust exemption and the catches
After two months of pressure, the Government announced on 18 June that genuine discretionary testamentary trusts would be exempt, including future ones.
The 8 July paper confirms the proposed design and puts qualifying testamentary trusts on the exempt list alongside deceased estates, charitable trusts, fixed trusts, widely held trusts and superannuation funds.
The first catch concerns where the income comes from.
Income generated from assets of the deceased estate will be exempt. Income from unrelated assets injected or added to the trust afterwards will not.
The approach is familiar. Since 2019, minors have received adult rates only on qualifying income related to and accumulated from deceased-estate assets. The proposed condition applies the same tracing principle to the minimum-tax exemption.
The second catch reaches into wills being drafted right now, and into wills signed long before anyone had heard of this measure.
For testamentary trusts established from 1 July 2028, the exemption is only available where the trust benefits individuals and income-tax-exempt entities such as charities. Not ordinary companies. Not taxable trusts.
Why that matters today
A testamentary trust is established on death, not on the day the will is signed. Most people holding wills today will still be alive on 1 July 2028, which means their trusts will be established under the new rule, drafted under the old assumptions.
Most testamentary trusts are drafted with deliberately wide beneficiary classes: the primary beneficiary (the person you ultimately want to benefit from your estate), their spouse, children, grandchildren, related trusts and related companies. That width was a sensible design for a future no one could map.
The paper does not say whether the mere presence of an ordinary company or taxable trust in the beneficiary class will be fatal, or whether the condition will turn on who actually receives a benefit.
So what should be done while the legislation is still being written?
For anyone making or updating a will now, the beneficiary class needs to be considered before signing, not after the legislation passes.
One conservative approach is to restrict it to individuals and income-tax-exempt entities. Another is to include a conditional restriction preventing any other entity from benefiting where its eligibility or an actual distribution would jeopardise the exemption.
For many families, distributions will in practice go to a spouse, children and grandchildren. If a corporate beneficiary or related trust is central to your plan, that needs specific advice. For the vast majority of everyone else, the power is cheaply surrendered for certainty.
What is no longer prudent is to leave a wide beneficiary class in place without considering the issue.
For anyone with an existing will containing a testamentary trust, the same logic applies. Now is the time to have it reviewed.
The silver lining
One real benefit has come out of this messy episode.
Testamentary trusts spent the winter in the papers and the Senate. People who had never heard of them are now asking their advisers a very good question: is there a trust in my will, and should there be?
For many families, the answer is yes.
If your children or grandchildren stand to inherit meaningful assets, if any beneficiary runs a business, works in a litigious profession, has a fragile marriage or is simply young or vulnerable, a testamentary trust deserves serious consideration.
The Government has now confirmed, in writing, that these structures are legitimate estate planning vehicles and will sit outside the new tax. A two-month political brawl is an odd way to run a public education campaign, but it worked.
What happens next
The paper is not law. Treasury expressly says that the proposed principles have not yet received Government approval.
None of that is a reason to wait. A will often takes effect on a date you do not choose, and a review now costs nothing if the final legislation turns out to be softer. Waiting has no upside. The only scenario in which waiting matters is the one where you did not get to update the will in time.
Submissions close on 31 July.
The direction, though, is set. The wills we sign today should be drafted with the proposed rule in view. How much flexibility to preserve is a judgment for each family. Whether to look at the question is not.
Check whether your will contains a testamentary trust. If it does, ask whether the beneficiary class needs narrowing. If it does not, ask whether it should.
The trust may not exist until you die. Whether it qualifies may be decided by the words you sign today.
Rachael Rofe is an estate planning lawyer and philanthropic giving expert, and the founder of Rofe + Counsel. She helps families and their advisers structure wealth transfer across life, death and legacy.