Trust tax changes to unfairly penalise vulnerable beneficiaries

"Much of the public commentary about these proposed changes has focused on tax. However, in estate planning practice, the tax concessions are only one small part of the reason families use testamentary discretionary trusts, and in many cases, tax is not the primary driver at all," said Lucke.

"Testamentary discretionary trusts are commonly used to protect young adults and minor children from receiving control of substantial inheritances too early and exposing the inheritance to the influence of bad actors, financial exploitation and financial immaturity."

They can also be used to provide flexible support for disabled or vulnerable beneficiaries or to preserve an inheritance for the benefit of a willmaker’s children, she added.

The government's 30 per cent minimum tax on discretionary trusts will result in discretionary testamentary trusts being hit with a 30 per cent tax from 1 July 2028 for trusts that were created after May 2026.

Lucke noted that under the existing tax rules for trusts, an adult who is earning at least $45,000 of income from sources other than trust distributions, such as salary, wages or directly held investments, would already pay a minimum of 30 per cent tax on trust distributions. This means there would be no additional tax paid under the new tax regime.

"However, beneficiaries who earn less than $45,000 of income from sources other than trust distributions will lose access to the tax-free threshold and 14 per cent marginal tax rate [would apply to] the income from their inheritance," she said.

Beneficiaries such as orphans, minors raised by grandparents, retirees, disabled beneficiaries who do not qualify for a special disability trust and adults in the sandwich generation who have reduced their employment to care for aging parents or children will be penalised by the new regime, said Lucke.

"One of the most concerning consequences of the proposed changes is the potential impact on young families where one parent dies," she said.

"While we understand that the exemption for income distributions from a testamentary discretionary trust to ‘vulnerable minors’ mentioned in the Budget material would include double orphans, this exemption should also be extended to include all minors."

Fixed testamentary trusts "not a solution"

While the government has made fixed testamentary trusts exempt from the 30 per cent trust tax, Lucke warned that simply switching testamentary discretionary trusts to fixed ones is not an effective solution for most Australians.

"Fixed testamentary trusts offer exactly zero asset protection nor do they protect young adults from bad actors and blowing through their inheritance. [This] is why most people choose a testamentary discretionary trust," she said.

"A fixed testamentary trust achieves nothing for a surviving spouses, or adult child, and is actually detrimental because they can’t control their own trust and inheritance.

"A fixed testamentary trust is only really suitable for a disabled or special needs adult who cannot qualify for a special disability trust or whose family is too rich."

She also warned that the existing definition of a fixed trust in the tax legislation is confusing and difficult to satisfy, with many taxpayers needing to apply for the Commissioner’s specific discretion to determine whether a trust is a fixed trust, or rely on safe harbour provisions set out in Practice Compliance Guidelines 2016/16. 

"This uncertainty and complexity further add to the confusion about how to create a fixed testamentary trust that satisfies the exemption," she said.

Recommendations for the government

Lucke is urging the government to exclude testamentary discretionary trusts from the proposed 30 per cent minimum tax regime entirely and has created a letter that other lawyers can send to their local MP.

With testamentary discretionary trusts fundamentally different from standard discretionary trusts, Lucke said the government should preserve the longstanding policy distinction between artificial income splitting and post-death family protection. 

"It also ensures that beneficiaries who are orphan children, disabled and vulnerable adult beneficiaries or low income earners are not penalised for accessing the protection they require," she said.

"Testamentary discretionary trusts should either be excluded from the proposed minimum tax regime entirely, or at the very least, the existing adult marginal tax rates should be preserved for income distributions to minors, disabled beneficiaries and low income beneficiaries."