In this weeks article I wanted to continue the business structuring discussions. To following on from the previous articles that focused on Profit First in Sole Trader and Company structures, this week I’m looking at my favourite business structure option of all…Discretionary Trusts.
While many Australian business owners are somewhat familiar with how a company works they are far less comfortable with Discretionary Trusts (often called Family Trusts). This results in many businesses being run inside companies purely because the business owner doesn’t understand the benefits the trust could offer.
What the heck is a Trust?
Trust law is complex and trust administration should always be left to professionals. Having said that, a very simple example of establishing and operating a Trust is below:
I give my wife (Jaine) $1,000 and ask her to look after it. To invest it in accordance with a list of rules i have written down and to ensure any profits generated go to our daughter (Melody).
We have just set up a very basic Trust. The members of my little family are playing the following roles:
- Settlor – myself
- Trustee – Jaine
- Beneficiary – Melody
- Trust Property/Asset – $1,000
- The Trust Deed – My list of ‘rules’
If you currently have a trust you might find a $10 note stapled to the front of the Trust deed. That’s your original Trust asset. Don’t lose it!
Why do I love them so much?
One word…Flexibility! Trusts allow your accountant to get creative at tax time and look for ways to better manage taxable income across your family group. They help to prevent situations in which most of the business income is taxed in the hands of one person. There are limits to what the trust can do and the rules are complex, but your accountant will be across it all.
Profit First and Discretionary Trusts
If you are operating your Australian business through a Trust (or considering it) what should you consider when implementing Profit First?
Trusts and Owners Pay
Unlike a company structure the trust can ‘give’ it’s profits to the business owner(s) without the need to put the payments through the payroll system and treat them as a salary or wage. You can process the business owners as salary employees if you wish, but you don’t have to. Furthermore, people can be beneficiaries of the trust even if they don’t actively work in the business.
As I mentioned earlier this increased flexibility allows your accountant to get creative, but you need to work closely with them through-out the year to ensure the profits are flowing to people who qualify as beneficiaries and in appropriate quantities.
Trusts and Superannuation
The superannuation system is a great ‘forced saving’ mechanism. Funds accumulate in your superannuation fund because the law says that if you are an employee you must have contributions made.
A trust structure allows us to distribute profits without compulsory superannuation contributions. This can be great in cases where you want to pay off personal debt or build investment wealth outside of superannuation but it’s not right for everyone. I always recommend a financial planner is involved in those discussions.
If you’d like to make contributions from your dstributions you can, but you’ll need to set aside the appropriate amounts from your Owner’s pay account and transfer them to your superfund.
If you accumulate the funds outside of superannuation and hold them until the end of the financial year then you can make the choice when you are doing tax planning.
Trusts and the Profit Account
The same principles apply to your quarterly profit from the Profit Account. In a trust we don’t have to put this through as a wage and pay superannuation on it. However, you should consider this part of your total ‘drawings’ from the trust for the year when discussing the topic with your accountant.
My message for all business owners who use a Discretionary Trust is this: In my opinion you have the best structure available for Profit First. While the system functions exactly as described in the book in any structure, the trust allows the maximum tax reduction potential for businesses that have outgrown the sole trader option. While they can be complex your accountant or Profit First Professional can guide you through every step.
Read our comprehensive review of Profit First here
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