Family Trust vs Discretionary Trust: Which Structure Could Help Australians

Many Australians looking at a trust structure want two things: a sensible way to hold family or business assets, and flexibility in managing taxable income as circumstances change. The terminology can be confusing, particularly when people compare a “family trust” with a “discretionary trust” as though they are competing structures.

In many cases, they are not. A discretionary trust is the underlying legal arrangement. A family trust is generally a trust that has made a family trust election for income tax purposes. Understanding that distinction matters before buying property, moving a business into a trust, adding beneficiaries, or making annual trust distributions.

The key distinction: a discretionary trust can become a family trust for tax purposes

A trust is an arrangement under which a trustee holds property for the benefit of beneficiaries. The trustee may be an individual or a company. A trust itself is not a company, although many private trusts use a company as trustee.

A discretionary trust is usually established by a trust deed. The deed identifies the trustee, outlines the powers of the trustee, defines the classes of beneficiaries and sets the rules for income and capital distributions. In a typical discretionary trust, no beneficiary has a fixed entitlement to a particular trust asset or a fixed share of trust income before the trustee exercises its discretion under the deed.

A “family trust” is often used informally to describe a discretionary trust established for a family group. However, the term has a more specific income tax meaning.

Under the trust loss rules, a trust is a family trust when a valid family trust election is in force. The election identifies a specified individual, and the relevant family group is determined around that person under the tax law. The trustee must satisfy the family control test before making the election.

This means a trust can be:

a discretionary trust with no family trust election;

a discretionary trust with a family trust election, often called a family discretionary trust;

another kind of trust, such as a fixed or unit trust, that has made a family trust election if eligible.

The practical takeaway is simple: a family trust election does not create the trust or change it from discretionary to non-discretionary. It is a tax election that can bring particular benefits and restrictions.

Why Australians use discretionary trusts

A well-designed discretionary trust can give a family or business group flexibility. That flexibility is often useful where income levels, family needs, investment plans or business roles are likely to change over time.

Depending on the trust deed, the trustee may be able to distribute trust income or capital among eligible beneficiaries in different proportions from year to year. This can assist with family wealth planning and may allow taxable trust income to be allocated to beneficiaries whose circumstances make that appropriate.

However, discretion is not unlimited. The trustee must act within the powers of the trust deed, follow the deed’s distribution provisions and properly document its decisions. The deed may impose earlier deadlines, restrict who can receive particular types of income, or require the trustee to deal with income and capital in a particular order.

For tax purposes, an adult resident beneficiary who is presently entitled to a share of trust income will generally include the appropriate share of the trust’s net income in their assessable income. The rules are technical and can produce outcomes that differ from the cash actually paid to a beneficiary.

That is why a discretionary trust should not be viewed as a simple “income-splitting” tool. It is a legal and tax structure requiring annual decisions, accurate records and careful follow-through.

Common reasons Australians consider a discretionary trust include:

operating a family business;

holding investment assets;

separating control of assets from personal ownership;

providing for a spouse, adult children or other family members;

creating flexibility for future family circumstances;

planning for the succession of control of a family investment structure.

Whether those goals are achieved will depend on the deed, the trustee’s conduct, the assets held, financing arrangements, beneficiary circumstances and the wider group structure.

Asset protection: useful separation, but not a guarantee

Asset protection is often a major reason people consider a discretionary trust. The concept is that trust assets are held by the trustee for beneficiaries, rather than being owned personally by an individual beneficiary.

Because beneficiaries of a discretionary trust generally do not have a fixed proprietary entitlement to a particular trust asset before the trustee exercises its discretion, the structure can offer a different ownership framework from holding an asset personally.

That said, a trust is not a complete shield against every financial or legal risk. Asset protection depends on the facts, and it can be weakened by poor structuring or conduct. Important issues can include:

whether the trust itself carries on a trading business;

whether valuable passive assets are held in the same trust as a higher-risk business;

whether an individual has personally guaranteed business or borrowing obligations;

whether the trustee has complied with the trust deed;

whether the trustee has acted within its powers;

whether assets were transferred after a creditor problem had already emerged;

family law, insolvency and estate-planning considerations;

the identity and powers of the appointor, trustee, directors and shareholders of a corporate trustee.

Using a corporate trustee is common because the company is a separate legal entity. However, it does not remove director responsibilities or personal exposure arising from guarantees, misconduct or limitations on the trustee company’s right to be indemnified from trust assets. ASIC specifically notes that directors of a corporate trustee may become personally responsible in some circumstances, including where the company breaches the trust terms, acts outside its authority, or lacks an effective right of indemnity.

A practical point for business owners is to consider whether the same trust should own both the operating business and valuable long-term investment assets. There is no universal answer, but mixing business risk and investment assets in one structure deserves deliberate legal and accounting advice rather than an off-the-shelf approach.

How trust distributions can affect tax outcomes

The tax attraction of a discretionary trust is usually flexibility, not a special trust tax rate. Trust income is commonly assessed to beneficiaries who become presently entitled under a valid trustee resolution, subject to the detailed rules in the tax law.

Before the end of each income year, trustees usually need to decide how distributable income will be allocated under the deed. The ATO’s guidance emphasises that a resolution needs to be made by the end of the income year, or earlier if the deed requires it, for it to be effective in determining who is assessed on the trust’s taxable income.

A sound distribution process involves more than selecting names and percentages. It should consider:

the terms of the trust deed;

who is actually eligible to receive a distribution;

each beneficiary’s tax position and legal capacity;

whether a beneficiary has provided their tax file number where required;

whether the trust has capital gains, franked distributions or other specially treated income;

whether the beneficiary will receive the funds, leave them owing to them, or lend them back under documented arrangements;

whether another entity, including a private company, is involved.

Trust capital gains and franked distributions have additional rules. The tax law allows particular tax attributes to be dealt with through specific entitlement and related provisions, but only where the legal and record-keeping requirements are satisfied. For example, a beneficiary’s specific entitlement to a trust capital gain depends on the trust terms, the financial benefit received or expected, and appropriate records made within the required period after year end.

This is one area where generic distribution minutes can create problems. The deed, trustee resolutions, financial accounts and tax return need to work together.

Trust distributions to minors, non-residents, beneficiaries under legal disability and entities with carried-forward losses can also be subject to different treatment. These situations should be reviewed before resolutions are signed.

Family trust elections: valuable in some cases, restrictive in others

A family trust election can be useful where a trust needs to access certain concessions within the trust loss and franking credit rules. Broadly, the election can help a trust be treated as an excepted trust for relevant trust loss purposes, but it also limits how freely the trust can distribute income and capital outside the nominated family group.

The election is not something to make automatically simply because the trust is called “The Smith Family Trust”. It needs to be considered in the context of the group’s current and future plans.

Once a family trust election is in force, a distribution outside the defined family group can trigger family trust distribution tax. The tax is imposed on the amount or value of the relevant income or capital, and the ATO warns trustees to identify existing elections and check intended beneficiaries carefully before making distributions.

The choice of the specified individual is especially important. It determines the family group for election purposes and can affect future flexibility involving relatives, associated entities, succession arrangements and other trusts or companies in the group.

Although the law allows revocation or variation in limited circumstances, those pathways are conditional. In particular, prior use of an election for tax losses, bad debt deductions or access to franking credit outcomes may affect whether a revocation is available.

For that reason, a family trust election should be treated as a long-term structural decision, not as a routine tax-return form.

Risks that can undermine an otherwise good structure

A discretionary trust can be effective only when it is administered properly. Problems often arise not because the original structure was unsuitable, but because the trustee has failed to follow the deed or allowed informal family arrangements to replace proper documentation.

One major risk area is where a beneficiary is made entitled to trust income but another person ultimately receives the economic benefit under an arrangement designed to reduce tax. The anti-avoidance rule in section 100A can apply to certain reimbursement agreements. The ATO’s binding ruling explains that the rule can apply where the relevant connection, benefit-to-another and tax-reduction-purpose requirements are met, unless the ordinary dealing exception applies.

Another common complexity arises when a private company is made presently entitled to trust income but does not receive the funds. Payments, loans or debt forgiveness involving the trust, company shareholders or their associates can potentially engage the Division 7A rules. These rules are detailed and should be addressed before funds are moved or retained, rather than after the trust tax return is prepared.

Other practical warning signs include:

trustee resolutions prepared after the relevant deadline;

distributing to someone who is not an eligible beneficiary under the deed;

failing to distinguish trust income from taxable net income;

assuming cash can be used by family members because it is “in the trust”;

amending a deed without reviewing tax, duty, land tax and succession consequences;

forgetting that a family trust election or interposed entity election already exists;

failing to update records when trustees, directors, shareholders or appointors change.

A practical scenario: choosing flexibility without creating future problems

Consider a couple running a growing professional services business. They want to build investments over time, support adult family members where appropriate and avoid holding every asset in their own names.

A discretionary trust with a corporate trustee may be worth exploring because it can provide a framework for holding assets and making distributions among a defined class of beneficiaries. If the business expects to carry forward losses, receive franked dividends through a group structure, or needs access to particular tax concessions, a family trust election may also be considered.

However, the right answer may not be to place every asset and activity into one trust. The couple would need advice on business risk, financing, guarantees, the trust deed, succession of control and whether an election would unnecessarily restrict future distributions. They would also need an annual process for trustee resolutions, accounts, tax returns and beneficiary loan accounts.

The value is not in having a trust with the right label. It is in having a structure that matches the family’s commercial, legal and tax position, and then administering it consistently.

Choosing the structure that fits your circumstances

For many Australians, the “family trust versus discretionary trust” question has a straightforward starting point: a family trust is commonly a discretionary trust that has made a family trust election for tax purposes.

A discretionary trust may offer flexibility in how income and capital are managed among eligible beneficiaries. It may also support broader asset-holding and succession planning objectives. But the structure is not a guaranteed asset-protection solution, and tax benefits depend on valid documentation, genuine beneficiary entitlements and compliance with complex rules.

A family trust election can be helpful where it supports a particular tax outcome, such as dealing with trust losses or franking credit rules. In exchange, it can significantly narrow who the trust can distribute to without adverse tax consequences.

This article is general information only and is not personal financial, legal or tax advice. Before establishing a trust, making a family trust election or changing trust arrangements, speak with a registered tax agent or accountant, such as, about your specific circumstances.