Understanding Trust Income vs. Taxable Income for Distributions

By Jaye Mankelow

For many clients operating family or discretionary trusts, understanding how trust income is calculated and distributed can seem complex. A common area of confusion lies in the difference between accounting income (trust income) and taxable income, particularly when the trust receives dividends with franking credits. This article breaks down the mechanics of trust distributions, focusing on scenarios involving fully franked dividends from a passive entity (subject to a 30% corporate tax rate). Note that some companies may be taxed at 25%, depending on their classification.

What Is Trust Income?

Trust income, also referred to as accounting income, represents the net income earned by the trust during a financial year. This income is what trustees distribute to beneficiaries and is determined by the terms outlined in the trust deed. Examples include:

• Dividends (excluding franking credits)
• Rent
• Business profits
• Interest income

Importantly, trust income often excludes non-cash tax adjustments such as franking credits or depreciation differences, making it distinct from taxable income.

What Is Taxable Income?

Taxable income is the net income the trust must report to the Australian Taxation Office (ATO), calculated under tax law. Taxable income includes:

• Assessable income
• Tax adjustments, such as grossed-up dividends with franking credits
• Capital gains or deductions, as defined by tax law

How Are Distributions Declared and Paid?

Trustees must distribute trust income (accounting income) to beneficiaries in line with the trust deed. The following mechanics are important:

1. Declaring Distributions: Trustees declare income distributions by 30 June each year, ensuring trust income is allocated to beneficiaries. This declaration is crucial to avoid the trustee being taxed on undistributed income.
2. Unpaid Present Entitlements (UPEs): If the declared distribution is not immediately paid to beneficiaries, it is recorded as an unpaid present entitlement (UPE). This is a legal liability for the trust to settle the distribution.
3. Payment Timing: While income is declared as of 30 June, the UPE is often settled after the preparation and lodgement of the trust’s tax return. Beneficiaries typically receive the payment within the following financial year.

Example: Distribution and Settlement

Let’s revisit a scenario where a trust earns fully franked dividends and rental income, with specific allocations to Beneficiary A and Beneficiary B.

Scenario

The trust earns the following during the financial year:

• $70,000 in fully franked dividends (with $30,000 franking credits).
• $50,000 in rental income.

The trustee allocates:

• Beneficiary A: All the franked dividend income.
• Beneficiary B: All the rental income.

Settlement of Distributions

• As of 30 June 2024, the trustee declares:
  • $70,000 of trust income allocated to Beneficiary A.
  • $50,000 of trust income allocated to Beneficiary B.
• If the amounts are not paid immediately, they are recorded as UPEs in the trust’s books:
  • Beneficiary A: $70,000 UPE
  • Beneficiary B: $50,000 UPE
• Once the trust’s tax return is lodged and the trust’s cash flow allows, these amounts are paid to the beneficiaries, typically within the following financial year.

Key Takeaways

• Accounting Income Determines Distributions: Trust income (Accounting income) governs how distributions are declared and the amounts beneficiaries are entitled to physically receive.
• UPEs Bridge Timing Gaps: Declared distributions are often settled later, recorded as UPEs to ensure compliance and clarity.
• Taxable Income May Differ: Beneficiaries’ taxable income can include additional components (e.g., franking credits) not reflected in Accounting/Trust income.

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Trust distributions involve careful management of both accounting and taxable income. Trustees must ensure distributions are declared correctly and paid in a timely manner while managing the trust’s cash flow and compliance obligations.

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If you have questions about your trust distributions or need assistance managing UPEs and tax compliance, our team of accountants and advisers is here to help simplify the process and maximise the tax efficiency of your trust.

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