What is a discretionary family trust?
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Table of Contents
A discretionary family trust is a legal tool used in Australia. A trustee holds assets for a group of potential beneficiaries. It’s called “discretionary” because the trustee gets to decide who gets income or capital each year, and how much.
The trust deed lays out all the important details: who the settlor is, who the trustee is, who the appointor is, what assets are in the trust, and who could benefit from it. For US expats, knowing this structure is important if they’re involved or may inherit from a trust like this.
How does this affect a US expat living abroad?
Even if the trust operates cleanly under Australian law, US tax rules may treat it as a grantor trust. The US person who established or settled the trust may get taxed in the US on all income, regardless of who actually receives distributions in Australia. That means the tax flexibility in Australia may offer no benefit under US tax law.
How discretionary trusts work: roles and flexibility
The trustee reviews the trust’s income and capital each year and decides which beneficiaries to pay and how much. The appointor, often a different person from the trustee, has the power to hire or fire the trustee. That gives someone control over decisions without owning trust assets directly.
How the ATO treats discretionary trusts for tax purposes
In Australia, discretionary trusts aren’t taxed like a company or individual. Instead, the tax is based on who actually gets the income from the trust. If the trustee distributes income to beneficiaries, then each beneficiary is taxed on what they receive. It’s taxed at their personal income tax rate.
Now, here’s where it gets important: if no one is chosen to receive the income for a particular year, which can happen if the trustee doesn’t make a decision or delays paperwork, the leftover income doesn’t just sit there tax-free.
The Australian Tax Office (ATO) can step in and tax that undistributed income at the top marginal rate, which is currently up to 45%. That’s a steep rate, and it can catch people off guard if they’re not paying close attention to deadlines and recordkeeping.
This usually applies in cases where the trust is set up so that the trustee has full control and isn’t required to distribute income. These are sometimes referred to as non-exhaustive trusts. So, while discretionary trusts offer flexibility, they also require careful timing and documentation to avoid expensive mistakes.
How does the IRS treat a discretionary family trust?
From the US side, these types of trusts are usually seen as foreign grantor trusts if the person who created or controls the trust is a US citizen or Green Card holder. In that case, the IRS says the person who set up the trust is responsible for paying US taxes on all the trust’s income.
That applies even if the income isn’t distributed to them or anyone else. So just because the trust didn’t make payments doesn’t mean the IRS won’t expect a tax return.
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Key benefits of discretionary family trusts in Australia
- Asset protection
Assets held in the trust are generally kept separate from the personal liabilities of beneficiaries or trustees. If someone is sued or goes bankrupt, creditors usually can’t reach trust assets. That provides a layer of protection for family wealth. - Tax flexibility
Trustees get to choose who receives income each year. By distributing to beneficiaries in lower tax brackets, families can reduce their overall tax burden. That flexibility can lead to meaningful savings at the family level.
Common limitations and compliance risks
- Risk of heavy penalties
Trustees must follow the trust deed and properly minute distributions. If income isn’t distributed by June 30 or documentation is missing, the ATO may tax undistributed income at a flat 45% rate. That’s a steep penalty that wipes out many of the trust’s advantages. - Mismanagement and disputes
Failing to document trustee decisions or beneficiary resolutions can lead to disputes among family members. Worse, a court might reject the asset protection benefits if the trust’s formalities aren’t properly maintained. - Loss of favorable US tax treatment
Certain income types (like capital gains) might be taxed differently in the US than in Australia. So if a trust generates capital gains that are tax-free or lightly taxed in Australia, the IRS may treat them as regular income and apply a higher rate. - Currency mismatches
Trust income or distributions in Australian dollars must be reported in US dollars. If exchange rates change significantly, it can affect how much taxable income the IRS thinks you’ve received, even if your actual financial position hasn’t changed. - Changing rules
Both the ATO and IRS have been increasing their scrutiny of trusts in recent years. What worked in the past might not be safe going forward. US expats can’t assume past advice is still up to date; it’s important to get a tax professional’s advice to stay current.
Considerations for US expats with Australian discretionary trusts
What does a US expat have to report?
If you’re the grantor, a trustee, or even just named as a potential beneficiary, you may need to file multiple forms. The most common ones are FBAR (Foreign Bank Account Report), Form 8938 for FATCA, and Forms 3520 and 3520-A. These forms are focused on reporting your involvement, not just actual income received.
What happens if you don’t file?
The IRS doesn’t take missed filings lightly. Even if no tax is due, not filing these forms can result in penalties starting at US$10,000, and they can increase quickly if the trust is large or there were multiple missed items.
Why is this important for US expats?
Discretionary family trusts are really common in Australia. So it’s possible you’re a trustee, a beneficiary, or maybe someone set one up for your family years ago. If you’ve moved overseas or hold dual citizenship, you might not realize that your connection to the trust brings US tax obligations with it.
FAQ'S
Can I receive money from an Australian discretionary trust if I live in the US?
Yes, you can receive distributions, but they must be reported to the IRS. You may also owe US tax on the income, even if it’s already taxed in Australia.
Do I have to tell the IRS about a trust if I never got any money from it?
Can I transfer money or property into a discretionary trust while living in the US?
Does using a discretionary trust help reduce my US taxes?
What happens if my Australian trust earns capital gains?
