Family trust elections in Australia: when to make one and the tax consequences

A family trust election (FTE) is a formal election by a discretionary trust to be treated as a "family trust" for income tax purposes. The election locks the trust distributions to a defined family group and unlocks several important tax concessions. It is one of the more consequential one-time tax decisions a trust controller will make.

When you need to make a FTE. The election is usually needed in practice to give beneficiaries access to franking credits above the $5,000 small shareholder threshold (the "45-day holding period rule" cannot be satisfied without it in many trust structures). It also makes it much easier to use prior-year tax losses under Schedule 2F of the ITAA 1936, which otherwise require the trust to pass the pattern of distributions, control and income injection tests.

The "family group". The election names a "primary individual" (the test individual). The family group includes the primary individual and their family as defined in section 272-95: parents, grandparents, brothers and sisters of the individual or their spouse; nephews, nieces and children of either, and their lineal descendants; and the spouses of all of these. It also includes other trusts with an FTE naming the same individual, companies, partnerships and trusts that have made an interposed entity election (or are wholly owned by family members through fixed entitlements), and certain deductible gift recipients. A family company is not in the group just because the family controls it: it needs an interposed entity election. Distributions to anyone outside the family group attract Family Trust Distribution Tax (FTDT) at the top marginal rate plus Medicare levy. The definition does not extend to friends or business partners outside the family.

Choosing the primary individual. The primary individual is typically a parent in a multi-generational family. The choice has long consequences: once made, the primary individual cannot be changed except in very narrow circumstances. Future events (death, divorce, marriage of children) can complicate distributions if the primary individual was not chosen with succession in mind. Tax advice on the primary individual choice is essential before the election is made.

Process. The election is lodged with the ATO using form NAT 2787 (Family Trust Election, Revocation or Variation). The form names the primary individual and specifies the income year from which the election is effective (typically retrospective to the start of the year of lodgement). An election can generally specify an earlier income year, back to 2004-05, if from the start of that year the trust passed the family control test and made all distributions within the family group. In practice it should be made at trust establishment or as soon as franking credit access is anticipated.

Common errors. Failing to make a FTE before claiming franking credits or prior-year losses (the claim can be disallowed unless a retrospective election is available). Distributing outside the family group inadvertently (triggering FTDT at the top marginal rate). Not updating the election when family circumstances change (although the primary individual cannot change, the family group composition shifts as people are born, marry, divorce, or die, and distribution decisions need to track these changes).

Practical advice. Consider the FTE at trust establishment if any of the trust beneficiaries will own shares in companies that pay franked dividends. Document the family group clearly in trust resolutions each year. Review distributions each year against the family group definition before signing the resolution. Tax advice essential before the election is made, and on each annual distribution decision. Once the election is in place, it operates for the life of the trust.