There’s a commonly-held belief that trusts are simply a way for the wealthy to get away with shielding their income from taxes. But that couldn’t be farther from the truth, as medical accountant Kym Nitschke explains.
Trusts do come with inherent tax benefits for the beneficiaries. It’s also true that the funds within the trust itself are not taxed, at all.
But does this mean that a doctor can put all of his or her income into a trust and thereby avoid paying income tax?
The short answer is ‘no’ because of how trusts work.
Trusts and Taxation
Trusts act like second businesses for doctors. Even if you set up a trust for your family you’ll still have to apply for an Australian Business Number for your fund. The trust supplies your practice with the additional services you need in exchange for fees that you pay. In return, any business profit generated by the trust goes to your family which they report as their income. Your family members must then pay the income tax on what they receive.
This is generally how it works: the funds are only taxed once when they are received as income. Neither you nor the trust are taxed beforehand, which is where a lot of the confusion comes in. The one who actually receives the ‘benefits’ of the income, the beneficiary, is the one who pays the tax.
It is a fact, however, that the beneficiaries enjoy a lower tax rate than if you reported that money as personally-earned income. The tax benefits reward the action of spreading out and streaming money to different beneficiaries.
Why You Can’t ‘Hide’ Wealth in a Trust
The goal of a trust is to ensure that business income goes to the right people at the right time. A trust protects assets from attempts by others to seize the money whether by claims of relationship or by filing a lawsuit. Trusts are meant for long-term planning to keep the profits coming in to the same family for generations.
Simply stashing away money in a trust doesn’t protect it from taxation. If you don’t distribute the income to others, you’ll be taxed at the highest marginal tax rate possible. So having a trust is not a loophole for doctors to avoid taxes – it can actually be a tax liability if not used correctly!
The law requires that the one who earns the money pays the income tax. Whatever money you earn as a doctor through your individual effort is subject to tax which you must pay. There is no sheltering such income in a trust for the purpose of avoiding your tax duty.
A trust is treated as a separate entity of its own for taxation purposes. While it is not a legal entity and cannot be taxed, it still needs to have its own tax return filed each year. This means that the government is aware of all the funds inside a trust.
The ATO is very suspicious of trusts, too. You must be prepared for the possibility of being audited if you maintain a trust. This means that you should be fully prepared and have transparent intentions when you approach the process of setting up a trust.
The Limitations of Trusts
In the end, trusts can only offer so much in tax savings. Splitting the income stream among family members or even just sharing it with a spouse can allow each member to save several thousand in taxes.
But after that yearly income pouring into the fund reaches $360,000, there are no further breaks. Up to that amount, there are some tax savings, but they are fairly insignificant to the truly wealthy who have more than $360,000 coming in each year.
The wealthy no longer derive much in the way of tax benefits by channelling their income to a trust. They get better benefits by keeping the income in a family-owned company.
Besides, most doctors, despite having a reputation for being ‘wealthy,’ only earn around $300,000 or less on average each year. Specialist practice and overtime may help you earn more. But overall, there are no tax loopholes via trusts for doctors!
Smart Use of Trusts for Medical Professionals
Trusts can help doctors by protecting assets and ensuring the equal and steady spread of business income to their families. The tax benefits are a perk, but not the main reason you should set up a trust.
Remember that trust funds are to benefit the beneficiaries and not the trustee. The trust is merely a business vehicle to accomplish that goal.
Nitschke Nancarrow specialise in accounting and financial planning for doctors and medical specialists.
– Kym Nitschke
With guidance from our friends at Andreyev Lawyers.
The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.
Taxation, legal and other matters referred to on this website are of a general nature only and are based on Nitschke Nancarrow’s interpretation of laws existing at the time and should not be relied upon in place of appropriate professional advice. Those laws may change from time to time.
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