Myth – Everyone who has a trust is ripping off the tax system.
Reality – this is a complicated topic that I have tried to keep simple and to 600 words, but first let me say that, yes, there are a significant number of people who are using the trust structure to minimise their tax bill – the worst offenders are the approximately 10,000 families that use the trust mechanism to minimise their income and then claim working for families. The cost of this to the taxpayer is around $58m. As I have noted previously, I find this offensive.
There are many others who have structured their affairs to ensure they pay a maximum rate of only 33% when, in fact, they earn significantly more than $70k (eg, a trust owns a trading company: the owner pays himself a salary of $70k (top tax rate of 33%), and the rest of the company’s profit flows to the trust in the form of a dividend, which is then disbursed to the trust beneficiaries at the final 33% rate). Remember, the trust tax rate is the final rate therefore the individual beneficiary of income from a trust only pays 33% no matter what their personal marginal tax rate is, whereas the individual beneficiary of dividends from a company pays tax on disbursements at their correct marginal tax rate. This is a complex area, however, very simply, you see why trust and income tax rates need to be aligned, but not so important for company and income rates.
There are, however, many many people who use Trusts for reason other than tax optimisation. For the vast majority of these people, the trust tax rate is irrelevant.
There are 4 reasons why people set up a family trust:
1. Estate planning – the creation of a fund specifically aimed at providing an identified source of income for a widow, unmarried daughter, disabled child etc. Also allows for the devolution of assets from one generation to the next – or the retention of given assets within family ownership through 2 or more generations. Can allow for management and governance structure for given identified assets.
2. Asset protection. Here the driving motive is the shielding of assets from third parties. This could be aimed either at protecting the assets themselves or alternatively the settlor. Matrimonial Property Agreements frequently contemplate the formation of dual or mirror trusts isolating and identifying two parties in individual contributions to the matrimonial venture – this is particularly the case for second marriages or where there are children of 2 marriages to be separately provided for.
3. Income splitting. Here the motivation is to structure one’s affairs so as to qualify for a given asset/income tested regime. Over recent years illustrations of this would be the creation of trusts deliberately capitalised and managed to produce qualification for rest home subsidies or tertiary education grants. Similarly, if there was contemplation of asset testing for national superannuation, the use of a trust might be a suitable vehicle.
4. Taxation. Over the years the taxation benefit to be gained by the use of Trusts has varied with the tax regime (as discussed above). They are not of practical value to those on salaries or wages. For trading trusts, however, value can be gained as mentioned above, because the trust tax rate is final.
So as can be seen, there are some who are using the trust structure to minimise their tax bill, but there are many kiwis who have trusts for reasons other than tax optimisaiton. Yes, work does need to be done around tax and trusts, but never assume that just because someone has a trust that they are using it for tax purposes.
Agreed
I’m glad to see you smiling again Spud.
Hi Jum,
Nice to see you 
NOT only tax dodging purposes are to be frowned upon. Removing assests fromthe claim of others is also not a greta hting in many situations. Mr Bryers is only one of an enormous number of people in business who use it this way. trusts used to avoid potential liability as a result of wrong doing neglgience, or just not being prepared to take the risk your investors take sucks.
Same as voluntary liquidation of companies on a project by project basis to avoid liability/consequences for a job done and paid for.
” For trading trusts, however, value can be gained as mentioned above, because the trust tax rate is final.”
Ummmmmm …… almost right. It would complete the description to describe the fact that distributions up to 6 months from the end of the Trust’s financial year will become income in the hands of the beneficiary and will attract the appropriate marginal tax rate of the beneficiary.
IMHO the amount of tax foregone by the use of trusts is probably greatest in the area of income splitting although the rule that ANY distribution to a child 16 years or under (above $1000) attracts the highest tax rate available mitigates that area so that the majority of benefit is gained by distributions no non-earning spouses.
Dead right David. As mentioned, a rather complex subject that I tried to make relatively simple, but your contribution is very much appreciated – Stuart
“to” non-earning spouses.
Good coverage of the concept Stuart
You don’t mention the considerable cost of setting up a trust and maintaining it though
I wonder how many MPs have trusts for at least one of the above reasons……99%
Thanks Raymon. I actually have a trust for asset protection – set up from my business days, but definitely maintained during political career. Don’t run any income through it though. Yes, cost can be high to both set up and maintain properly.
I’ve investigated setting up a trust and I earn well under 70K, I believe those using a trust to claim working for families should be consider crooks…
Well written Stuart. Now I would like to see something on how to actually stop those who are using trusts so that they pay less tax & child support etc.
I for one have thought about setting up a trust so as to protect our children from future partners etc in terms of their inheritance from our estate (provided of course we have one!).
And yes Raymond, the cost is considerable hence why we have yet to do it. Which then highlights the fact that many who do set up trusts have the considerable fortune to do so and possibly the motivation to avoid paying their fair share.
So yes they certainly have their uses, but some tinkering would be welcome.
JeremY: I agree. I believe that ANYONE who has their snout in the trough and/or avoids paying their fair share is very much a crook and very much a bludger.
Hi Rebecca – my personal view would be that you probably should set up a trust if you are separated / divorced with children and some wealth in order to protect you and your children from worst-case scenarios.
Raymond and Rebecca what costs have you been quoted?
Rebecca, Tracey there is a trap when comparing a Trust which holds a property (for example) with one that earns income and is used to create tax advantages. The principle difference lies in the need to register the income earning trust with IRD and to file tax returns, operate nank accounts etc. As a result, there is a greater onus and possibly personal liability on the Trustees who must ensure that the administrative requiremnts of the Trustee Act are met and the Trust Deed conditions are complied with.
A trust that holds a house on the other hand requires no bank account, no accounting services, no tax returns etc. If there is a gifting programme that will need some annual documantation but that is about it. The Trustees need to sign off on the gifting but otherwise have no involvement unless there is an intention to do something with the property or add to the assets held.
The cost differences between these can be quite large.
DavidW
Thanks, that is one reason I am asking Rebecca and Raymond what they have been told the costs are? Trust Deeds are pretty much pro forma, and the annual cost of maintaining them, for average trusts (if such a thing exists) is minimal.
David thanks for that – Trusts is something I yet to get my head around completely!
Tracey we were quoted $3000 to set the trust up (for our assets etc). I don’t know what the ongoing costs would be.
Out of interest, why do you think your children will need protection from future partners, in terms of their inheritance? Assuming, as you say, that you have one to give.
A relatively simple trust was about $3000 with on-going costs of maybe $1000
Why, we have not intention that any wealth we have accumulated going to people who are not related to us
In theory if we lived long enough we could avoid having to pay for our retirment home costs but I think that would not cut in till we are over 100
To have a lawyer set up an asset protection trust from scratch is between $1000 – $3000 depending on how complex. Unsure for a trading trust. Most will have a proforma they can use, but it does still need to be specific to the situation at hand. Cost of maintanence isn’t that high, but it does need annual maintenance especially if there is a gifting regime in palce, and trustees need to sign forms etc etc.
@Tracey.
If they live with someone for 3 years and then break up, the other person is entitled to half of what is theirs, they could end up losing it. Never know what is down the track.
exactly – and that’s why you need a trust if separated/divorced with assets gained before embarking on a new relationship.
Ok, well make a trust from your wills. Leave everything you own in trust for your children or grandchildren, then the estate sets up the trust from estate funds, and oversees its running. It’s not like you care at that point, so let your inheritance pay the trust set up costs and you keep spending the fruits of your labour until you shuffle off.
Tracey: we have thought a family trust might be a good idea in terms of protecting the children against future partners re relationship break-ups, especially with the property act applying to de factos. When couples have been together for more than 3 years then everything (e.g including our house which would be left to them) is usually be split 50/50. Could be difficult to get out on for various reasons. Where we are most concerned is if say they were involved in an abusive relationship or something like that. We just want to protect them and any future children.
Tracey – a must for the very reasons you have outlined.! Stuart
oh, just seen you have replied/a mother has replied for me! the executor of our estate will be managing any funds/assets until the children turn 30 – figured that was a good alternative in terms of allowing the children to grow up before they get full access to everything. seems a little morbid. haven’t thought of the executor setting up a trust once we’re gone. not quite sure how the trust from the wills things works. might check it out – thanks!
Sounds like a great plan Rebecca!
IF you leave to them, even via Trust, depending on how they use the income or capital from the Trust the spouse can still benefit, but I see what you mean.
Basically by leaving it in trust via your will, there is no trust until you die, the trust is set up as part of your estate, and then those you name in your will are made beneficiaries.
Everyone with children under 18 ought to at least have made guardian appointments via your wills. Make sure you discuss with the people you envisage being guardians first. You’d be surprised how many do not want the task. They can refuse after you are dead, so better to be sure. DONT make them people older than you. People I meet always say about wills “yes, we keep meaning to do that”, but truly, it’s a must especially with children.
Wills are pretty standard so dont let somelawyer charge you an arm and a leg for them.
disclaimer: this post is not a replacement for legal advice
Rebecca – If its just managing assets I had recent quote of $2000 + $250 per year, + hourly rate for complicated structures. fro Prudential (including the professional indemnity), I would assume similar for Guardian. They are also familiar with setting up trusts from a will.
My own Trust (GST Reg from accountant) only cost $2150 + $250 + accounting work. Always looked at it as asset protection (save my kids house from suits), as well run companies can do better tax minimization.
Try the big companies for a simple effective trust such as you describe.
Tracey – thanks. Already had guardians sorted – people should probably sort that before their children are born as you don’t know when your number is up!
Jeremy – thanks also. Our Wills are with a big firm so no doubt would be easy enough to set up. Like trust from estate idea though as until we die it is unnecessary – kids won’t be getting squat until we knock off!
see my comments throughout. There is some great advice posted and some very helpful comments. As mentioned by Tracey – none is in lieu of legal advice, so do seek this, but from what I have read, it is very much common sense, and the reason why I have a trust. The one disadvantage of a trust is that legally, you actually do lose control of your assets, as they are owned by the trust and administered by the trustees – and they must act in the best interest of the trust itself, so they are well within their rights to deny disbursements if they deem them not to be in the best interests of the trust. Just something to be aware of.
Thanks Stuart yes that was another reason why we have hesitated. I think the suggestion for it to be formed via our estate is a great solution so will look into that and check it out with our lawyer.
Great that you have made the distinction between the different kinds of Trusts and intentions for forming them…..now if we could only get the Tax Administration Act to apply that too….!
Perhaps one thing could be to actually ascertain IF a Trust is having its decisions made by one of the beneficiaires, de facto or directly. Of cours ein most trusts one of the Trustees is a beneficiary. On the other hand beware porfessional trustees who rort people for Trustee fees.
A better idea which would simplify things, remove a lot of the bureacracy and remove the unfairness would be
1. Tax free income up to $10k. Maybe adopt that idea of a guaranteed $10k, although there would have to be restrictions on it.
2. Get rid of working for families and have the dpb and dole on a sliding scale where it reduces by say 20% a year.
3. Lower the company tax rate to 25%
4. Make all income over say $70k taxed at say 15%.
5. Since most people would fall in the $10-70k bracket, have a vote each election as to a percentage to pay in tax.
6. Make it a legal requirement for the government to not budget to spend any more than the forecast tax take.
Pete I like the way you think – if only the government would be so bold!
I personally like 1, 2 & 3 with an extra bits added on such as making all income tax from $10k up a flat rate of 25% with a top rate of 45% coming in at say $200k. Keep trust rates at company rate & increase GST for all luxury items to 20%.
While government’s would baulk at the idea of such drastic cuts as they would clearly remove the incentives for people to rort the system I think overall they would have more revenue.
5 & 6 are interesting too…
Supporting Peter’s 2,4,5 and 6, should mean you were unfit to participate in any legal process.
2 – most women on the DPB simple lose their partner and are unable to work while children are young, that will not change within a year. Nor will they retrain/upskill within a year. It’s just immature thinking or shock pretend radicalism. Otherwise, if you want crime punish the unemployed for the lack of jobs.
4 – let’s propose taxing rich people less than others … and see who says great.
5 – let’s fix the electoral system so the few rule over the many, and lets see who know their opinions are of the minority but want government to reflect their views anyway.
6 – look at what happened in California, one of the richest areas in the world is effectively a failed state.
Peter, nice effort indeed.
However it has to be costed, because rightly or wrongly, a drastic fall in overall take would have huge impacts on services, hsopitals schools etc, so there would have to be some kind of bridging, how that would work I have no idea.
I confess I live in a household which earns over $70k per year. I dont think about tax rates as much as some. I’ve also never voted based on which party will deliver more to my pocket. Not saying people dont and ought not, just saying.
I see no reason for a trust except for circumstances of inheritance where you wish the money to wait till the person is a certain age or used for a certain purpose OR where you have community organisation/charity type situations where a trust is required to run them effectively.
Most marriage and inheritance situations could be solved by prenuptial agreements and wills. The need for a trust where it is both moral and legal to do so is exceedingly small. With the number of trusts we have set up in New Zealand I would quite happily say that the majority are immoral.
Good post though, thank you for highlighting the different uses.