Trusts: key focus area for IRD

Date: 12th February 2015

The IRD have identified key areas – specific tax-related issues – that they are currently focusing on. One of these focus areas is trusts. They have stated ‘before you set up, manage or receive income from a trust, make sure you understand your tax responsibilities. Otherwise, you might face penalties or end up with an unexpected tax bill.’

Let’s look at one of the most common types of trust – a Family Trust– what they are; what the benefits are; and what to consider before setting one up.

What is a Family Trust?

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A family trust is a legal way to hold and protect your assets, such as investments or property, for you and your family for the future. The assets will be owned by the trust rather than by a person, and they are managed by trustees (e.g. a family member, a lawyer, or an accountant) for the beneficiaries (usually family members).

Benefits of a family trust

A family trust may be useful to:

  • Protect selected assets against claims and creditors, for example, to protect your family home from the potential failure of a business.
  • Set aside money for special reasons, such as a child or grandchild’s education.
  • Ensure your children, not their partners, keep their inheritances.
  • Avoid unwanted claims on your estate when you die, such as from a former partner.

Who’s involved?

  • Settlor: The person/people or company who creates the trust.
  • Trustees: The people who manage the trust. If you are the settlor you can also be a trustee. It’s also a good idea to appoint an independent trustee like a lawyer or accountant.
  • Beneficiaries: The people who benefit from the trust, for example you or members of your family.

The settlor can have the power to appoint and remove trustees. This is an important power that you can also transfer to someone else in your will.

Note that a trust doesn’t necessarily end with your death – it can last for a maximum of 80 years from inception.

What’s involved?

First you will need to decide what things you own should be put into the trust, and what their value is.  In most cases this will be the family home, but other things of value like shares and artwork can also be included.

The ownership of these assets will then be transferred to the trust and the trust then owes a debt back to you, the settlor. This debt can then be ‘forgiven’ through a process called gifting.

A legal document called a ‘trust deed’ will formally set up the trust. It will appoint the trustees, list the beneficiaries, and state various rules for the administration and management of the trust. The trust deed needs to be very carefully written, preferably by a lawyer.

More about asset transfer and gifting

Costs of trusts

Family trusts can be complex and time consuming to administer. It costs money to set them up and there are generally ongoing legal and accounting fees.

The trustee must file an Income tax return for the trust each year (this return is separate from the trustee’s own personal tax return). A person who receives beneficiary income from any type of trust, or a taxable distribution from a foreign trust, must include this income in their tax return for that year, and pay tax on it at their normal rates.

Think carefully about who will be the trustees, as they will be responsible for managing the trust properly. Your will should nominate people to be trustees after you die.

Risks of trusts

If a trust is not set up or managed well, there can be considerable inconvenience and cost.

You could also run the risk of having the trust declared a ‘sham’, which would mean that the assets are not really the trust’s but are in fact still yours. If the trust is a sham you may lose all of the advantages that you were hoping to gain from it, and you may be penalised as well.

Once you put your assets into a trust, you no longer personally own or control them. Instead, ownership passes to the appointed trustees who must act under the terms of the trust deed in the best interests of the beneficiaries.

Forming a trust is a big decision. If you are going to form one, make sure that it is established properly, for the right reasons, and managed well.

Contact us if you would like to discuss setting up or managing a Family Trust.

Sources and further information

Citizens Advice Bureau

Inland Revenue

Posted in: Alexandra, Christchurch, Latest News, Queenstown, Wanaka