For estates, there are special provisions that mean any income they receive can be taxed as if it were the deceased’s income for twelve months post their death. Trusts set up for disabled people are also covered by these rules, meaning their trustee income will be treated as though it was from the disabled beneficiary themselves – even though the nature of this income will remain unchanged.
What’s the rationale behind the change?
The new law seeks to close a loophole in the tax system. Previously, high-earners could avoid paying the highest tax rate by using a trust. But now the law states that trusts must pay taxes at the same rate as people’s top personal income rate.
To illustrate our point, think of a couple who settle a trust with their income-generating assets. One earns $180k and one earns $70k, while the trust generates $40k taxable income. When the income is retained in the trust, it will be taxed at 39%. The Inland Revenue’s solution says to distribute the income to the lower earner so they can benefit from a 33% tax on their beneficiary income instead.
Say, in the following year, when the trust generates $50k taxable income, Inland Revenue offers up another suggestion – to distribute this income to one of their children (who is not a minor beneficiary) so they only need to pay much lower marginal rates.
How will this impact me?
If you are a middle-class New Zealand taxpayer with a trust(s), the change will likely have a significant negative impact on you. Enough of an impact that Inland Revenue created a Fact Sheet that shows how to mitigate any tax excesses from this policy.
This change appears to be an indication that Inland Revenue sees trusts primarily as a vehicle to pay less tax. However, it’s important to understand that trusts are more than just a tool for reducing taxes. For years, families here in New Zealand have used them to create, grow, and safeguard wealth for generations. There are real business and family risks to look out for when managing trusts – from litigious issues to disagreements over how to divide assets. Yes, tax may factor into the equation at some point, but most often it isn’t the primary motivator. In the vast majority of cases, other considerations come first.
The trustee tax rate is one flat rate, unlike the varying individual marginal tax rates. This means that any income earned in trusts will now be taxed at 39% when it would have been 33% for individuals. Ultimately, there is a view it will punish people who are trying their best to make an income and create wealth, given they will likely end up with less post-tax money in their trusts.
Distributing income to beneficiaries in order to lower taxes can be an easy fix, but is it necessarily the best answer?
A trustee’s goal is to protect the wealth of their beneficiaries, they do not want to be in a position of building wealth, and providing a cash pay-out or credit isn’t always wise and can start depleting trust wealth. Surely protecting this wealth needs to be more important than solely mitigating taxes?
Now that the trustee tax rate has been raised, perhaps it’s time for Inland Revenue to consider whether the $1,000 designation for the minor beneficiary rule should be changed. It appears there may be sound reasons to raise this particular threshold significantly.
What can I do to prepare?
Ensuring trusts don’t fall victim to the higher trustee tax rate can be difficult. However, there are some actions you can take pre-emptively to ensure your trust is well taken care of come April 2024.
- Where trusts own shares in a company, think about paying fully imputed dividends before 31 March 2024 to clear the imputation credit account (ICA) and ensure 33% tax for the trusts.
- Bring forward the third provisional tax payment to 31 March 2024 so that imputation credits can be used to pay fully imputed dividends.
- Review all ICA balances prior to dividend payments to the trusts to guarantee there won’t be an imputation debit balance upon payment.
- Perform planning on whether income should stay in a company or be distributed to trusts.