In most cases a trust does not pay tax itself. A trust is generally a flow-through structure, which means its income passes to the beneficiaries, who each pay tax on their share at their own marginal rates, so the tax is usually paid by the people who receive the income rather than by the trust. The important exception is that the trustee is taxed directly on any income that is not distributed to a beneficiary, and this undistributed income is taxed at the top marginal rate, which is why well-run trusts distribute their income each year. The trustee is also assessed on behalf of certain beneficiaries, such as minors and non-residents. So the honest answer is that a trust rarely pays tax when it is managed properly, but income left in the trust is taxed harshly, and the trust still has to lodge its own return every year regardless of who ends up paying the tax.
How trust income is taxed: the flow-through principle
The key to understanding trust tax is that a trust is not taxed the way a company is. A company pays tax on its profits at the company rate and is a taxpayer in its own right. A trust, by contrast, generally acts as a conduit: it earns income, and that income is then distributed to the beneficiaries, who include their share in their own tax returns and pay tax on it at whatever rate applies to them. The trust itself usually pays nothing, because the income has been passed through to the people who are entitled to it.
This is why trusts are used so widely in Australia for family businesses, investments, and estate planning. The income can be directed to beneficiaries, and each beneficiary is taxed on their share at their own rate, rather than all of it being taxed in one place at one rate. The trust is the vehicle; the tax is generally paid by the beneficiaries. Understanding this flow-through is the whole answer to whether trusts pay tax: usually they do not, because the beneficiaries do.
Beneficiaries presently entitled pay the tax
The mechanism that makes the flow-through work is a concept called present entitlement. A beneficiary who is presently entitled to a share of the trust’s income for the year is taxed on that share, whether or not the money has actually been paid to them yet. So if a trust distributes its income to adult beneficiaries each year, those beneficiaries declare their shares in their own returns and pay tax at their own marginal rates, and the trust pays nothing on that income.
Each beneficiary is taxed as if the income were their own, which means an adult beneficiary gets the benefit of the tax-free threshold and the ordinary marginal rates, and a company beneficiary is taxed at the company rate. This is the normal, intended outcome for a well-run trust: all the income is distributed, every dollar is picked up by a presently entitled beneficiary, and the tax is spread across those beneficiaries at their own rates. The trustee’s job is to make sure beneficiaries are made presently entitled to all the income before the end of the financial year, usually by a trustee resolution, so that none is left for the trust to be taxed on.
When the trustee is taxed instead
The trustee, rather than a beneficiary, is assessed and pays the tax in specific situations, and this is where a trust effectively does pay tax. The main case is undistributed or accumulated income: if there is income to which no beneficiary is presently entitled at the end of the year, the trustee is taxed on it. Crucially, this is generally taxed at the highest marginal tax rate, not at a stepped scale with a tax-free threshold. So income left sitting in the trust is taxed at the top rate, which is a strong penalty and the reason trusts are careful to distribute everything each year.
The trustee is also assessed on behalf of certain beneficiaries even when income is distributed to them. For a beneficiary who is a minor, the trustee is taxed on that beneficiary’s share, and the penalty rates that apply to a minor’s unearned income mean distributions to children are taxed harshly beyond a small amount, a point we explain in our guide on who pays tax on a child’s savings. The trustee is also assessed on behalf of non-resident beneficiaries, who may then claim a credit for the tax the trustee paid. In these cases the trust is paying tax, but on behalf of a beneficiary rather than because income was accumulated.
The trust still lodges a tax return
Even though the trust usually pays no tax itself, it is not off the hook administratively. A trust must lodge its own trust tax return each year, reporting its income, its deductions, and how the net income has been distributed among the beneficiaries. The return shows the full picture: what the trust earned and who became presently entitled to each share. The trustee then gives each beneficiary a statement of their share of the net income so they can include it correctly in their own returns.
So lodging a trust return and paying tax are two different things. The trust lodges every year without fail; whether any tax is payable depends on whether all the income was distributed. This is one reason running a trust properly involves more administration than people expect, and why trusts are usually managed with an accountant. Our guide on what your accountant needs for your business tax return covers the kind of records that make a trust return straightforward.
Capital gains and franked dividends flow through too
The flow-through applies not just to ordinary income but to the particular character of that income. If a trust makes a capital gain, a beneficiary presently entitled to it can generally apply their own 50% CGT discount, and if the trust receives franked dividends, the franking credits can flow through to the beneficiaries along with the dividend income. This is part of what makes trusts flexible: the income keeps its character as it passes to the beneficiaries, so the discounts and credits are not lost in the trust. It does, however, add complexity, because the streaming of capital gains and franked dividends to particular beneficiaries has to be done correctly under the trust deed and the tax rules.
Why distributing all the income matters so much
Putting the pieces together explains the single most important habit in running a trust: distribute all the income each year. Because undistributed income is taxed in the trustee’s hands at the top marginal rate, leaving income in the trust is almost always the worst outcome, far more expensive than distributing it to beneficiaries taxed at their own, usually lower, rates. This is why trustees make resolutions before 30 June each year deciding who is presently entitled to the income, so that none of it is left to be taxed at the penalty rate.
It also explains why trusts are valued for the flexibility to direct income to beneficiaries on lower rates, within the rules. A discretionary or family trust can distribute to different beneficiaries each year, which can be tax-effective, but it has to reflect genuine entitlements and comply with the law. The ATO scrutinises arrangements where distributions are made on paper to low-rate beneficiaries but the benefit actually goes to someone else, so the flexibility is real but not unlimited. This is squarely the kind of thing to get right with advice, and our business and tax advisers help trustees make and document these decisions each year.
Family trust and other special rules
Several additional rules can apply depending on the trust. A family trust election can lock in a defined family group for certain tax benefits, but distributions outside that group then attract family trust distribution tax at the top rate, so it is a decision with consequences. If a trust distributes to a company beneficiary and does not actually pay the amount, the unpaid present entitlement can raise issues similar to the Division 7A rules that apply to company loans. Deceased estates, which are a type of trust, are taxed under modified rules that can give the estate access to ordinary individual rates for a period rather than the top rate. These are specialist areas, and they are the reason trusts really do need professional handling rather than a do-it-yourself approach.
The other meaning: client and statutory trust accounts
There is a second, quite different meaning of “trust account” worth clearing up, because the phrase is also used for the statutory trust accounts that solicitors, real estate agents, conveyancers, and some other professionals must keep to hold money on behalf of their clients. These are not investment or family trusts; they are regulated accounts holding other people’s money, such as a deposit on a property or funds held pending settlement.
The tax treatment of these is different and usually simpler from the account holder’s point of view: the money in the account is not the professional’s income, so they are not taxed on the funds themselves, and any interest earned is typically dealt with under the rules governing that profession, often paid to a statutory fund or to the client who beneficially owns the money, rather than being the firm’s taxable income. If your question is about this kind of trust account, the short answer is that the firm holding it is not taxed on the clients’ money, and the tax on any interest follows whoever beneficially owns it or the statutory scheme that governs it. If you operate one of these accounts for your business, how the interest is treated is worth confirming, and our taxation services team can advise.
A quick example of how it works
Suppose a family trust earns $90,000 of net income in a year. If the trustee resolves before 30 June to distribute $45,000 each to two adult beneficiaries who are presently entitled, each beneficiary includes their $45,000 in their own return and pays tax at their own marginal rate, and the trust pays nothing. If instead the trustee distributed only $60,000 and left $30,000 undistributed, that $30,000 would be taxed in the trustee’s hands at the top marginal rate, roughly $14,100 plus the Medicare levy, far more than it would have cost in a beneficiary’s hands. And if one of the intended beneficiaries were a young child, the trustee would be taxed on that child’s share at the minor penalty rates, which quickly reach the top rate above a small threshold. The example makes the rule concrete: distribute to the right beneficiaries and the trust pays little or nothing; leave income behind, or push it to a minor, and it is taxed at the harshest rate in the system.
Which trusts this applies to
These principles apply across the common trust types, with variations. Discretionary (family) trusts, where the trustee chooses each year who receives what, are the most common and rely heavily on the yearly distribution resolution. Unit trusts, where beneficiaries hold fixed units, distribute according to unit holdings rather than discretion, but the flow-through to unit holders works the same way. Fixed trusts and testamentary trusts created under a will each have their own features, and a self-managed super fund, although a type of trust, is taxed under the separate superannuation rules at concessional rates rather than the trust rules described here. The common thread for ordinary investment and family trusts is the same: income distributed to presently entitled beneficiaries is taxed to them, and income left behind is taxed to the trustee at the top rate.
