Diana Clement: It's definitely a matter of trust

We've all seen the adverts on TV. Your darling daughter hooks up with the class buffoon and he walks off with half of everything you've put aside for your children.

Not surprisingly family trusts are popular in New Zealand and we have 244,000 of them registered with the IRD.

Unfortunately the Government tightened the noose on tax breaks for family trusts in 2002. None the less there are ways and means of tweaking your use of family trusts to save tax and protect your assets.

The six month rule

Trust specialist Garth Melville, managing director of Company Solutions, says trusts are taxed at 33 per cent, but taxpayers on 39 per cent must pay the extra to the Inland Revenue on any profits passed out to them from the trust. If you leave those profits in the trust for six months after the tax year's end the profits can be distributed with no further tax to pay.

Conversely says Rebecca Grbin, tax partner at Deloitte, if you have a trust beneficiary who pays a 19.5 per cent tax rate you might want to pay profits out to them before the six months is up so that you save tax.

Charity distributions

The other "stunner" says Melville is the fact that trusts can distribute to charities and churches from pre-tax income. That means if you want to donate $1000 or $10,000 a year to your charity of choice, donating that money from your family trust will cost you less than from your own pocket. That is providing your trust earns gross income in the form of rents, royalties or leasehold fees that has not already been taxed. The charity (and one church per trust) does not pay tax on the donation provided it is a registered charity. For every $10,000 you pay, you're saving $3900 if you're a top rate tax payer - an opportunity that too few people have thought about.

A discussion document was released by the Inland Revenue Department last week, but doesn't appear to close this opportunity, says Grbin.

Offsetting profits

It's not possible to offset losses from one trust to another. You can, however, pass certain profits from a profit-making trust to a loss-making trust. If they haven't yet been taxed, then they may well become tax free if the losses cancel out the profits.

Geriatric care costs

Sad but true, says lawyer Ross Holmes and author of the book Success with Trusts, full-time geriatric care costs $3000 a month, plus your pension. Fine if you're single and have no dependants to inherit your wealth. But pity the poor spouse left at home footing the bill, right down to the last $160,000 equity in their home and all other assets. The good news is that recent changes to the law mean if you transfer your home into a family trust, then any increase in value from then on will escape the geriatric care means test. Add to that the $27,000 per year (or $54,000 for a couple) you can gift to their trust each year, you can build up a considerable chunk of money over time. "These exceptions are only of benefit for people who start planning well in advance," says Holmes.

Protecting the bloodline

It's worth putting your home and assets in a family trust before starting a new relationship, says Holmes, in case Mr or Mrs Hercules comes along and takes half after three years. Even when partners and spouses are specifically "precluded" as beneficiaries from trusts they can contest a will. Your will, says Holmes, should leave your assets to a trust. "It doesn't save tax, but it does save your assets." Holmes adds that too many people fail to think what would happen to their trusts' assets if they and their children all died at the same time.

Paying for children's education

Since 2002, minors who receive money from trusts have been taxed at 33 per cent - even though most are on the 19.5 per cent marginal tax rate. If, however you've got children in full-time education (school or university) that are over the age of 16, trust profits can be used to pay their education taxed at their marginal tax rate. If the parent or parents are paying 39 per cent tax, then paying just 19.5 per cent tax on the money used to fund your children's education is a tax saving indeed.

Trading trusts

Grbin says trading trusts can be useful for business owners to shelter some of their income against tax. If, for example, you are a dentist and the market value of your work is $100,000 a year, yet you earn $150,000 a year, the amount you earn over and above your market value can be retained by your trading trust and taxed at 33 per cent, not the 39 per cent it would be otherwise. It can be difficult, however, to transfer an existing business into a trading trust without it appearing as tax avoidance, says Grbin. "For new start-up businesses, this is a real opportunity."

Trust expert Bill Patterson, of Patterson Hopkins in Auckland, says probably the top trick with trusts is not to extract every last cent of tax savings, but to employ a co-operative approach to managing it - making family members less likely to "hover around the grave" waiting to blow the money on a new Porsche.

It was reported following the Association of Superannuation Funds of New Zealand (Asfonz) conference last week that minors under the age of 16 would be able to qualify for $1000 of free money from the Government's KiwiSaver accounts if they were employed by family trusts to do jobs such as lawn mowing.

However, trust experts we spoke to said it wouldn't fly and you'd end up paying more to your accountant to administer the ruse than you'd get from the Government.

None the less, it will be possible for self-employed people and business owners to put their children on the payroll and thus qualify them for KiwiSaver, says Holmes.

Part-time teenage workers will also qualify.

* Meanwhile Government proposals to raise the tax rate on family trusts to 36 per cent from the current 33 per cent is based on a "fallacy" that most people with trusts pay tax at 39 per cent and have trusts as a tax ruse, says Patterson. The Trustees Association has described this tax increase as "inheritance tax in disguise".