(Blog post author: Andrew Graham)
It is important that Executors carefully consider the taxation implications before distributing assets of an estate.
An estate at law is a trust, where the executor (and also in most cases the trustee) is the trustee of the trust, and the beneficiaries stated in the Will are the beneficiaries of the trust. The terms of the trust are set out in the Will.
Ordinarily, a trustee will only be assessed to tax of the trust in cases where no beneficiary is presently entitled, namely under Section 99 or Section 99A (which contains penal provisions) of the Income Tax Assessment Act 1997 (“ITAA 1997”). The Commissioner of Taxation is happy to accept tax from the trustee under Section 99 of the ITAA 1997, where the trustee is treated as an individual tax payer. Under current income tax rates, no tax is payable on the first $18,200.00 of taxable income, tax at 19% is payable on incomes between $18,201.00 and $37,000.00, at 32.5% for incomes between $37,001.00 and $90,000.00; at 37% on incomes between $90,001.00 to $180,000.00 and 45% for incomes of $180,001.00 and over. (The Medicare levy, currently at 2%, is payable in addition to the above tax rates).
An estate may be continued for tax purposes for up to three (3) years after the date of death, being the financial year in which the deceased died and two (2) subsequent financial years. It is important that an executor consider whether it is preferable for the executor to pay tax on income of the trust estate (i.e. between the date of death and the end of the financial year of the date of death) or whether the individual beneficiaries should.
Ultimately this decision, and also when to make a final distribution of assets of the trust estate, will depend upon the estimated income of the estate and the likely tax rates of the beneficiaries.
In a case where some or all of the beneficiaries are not liable to tax (such as tax-exempt charities) or are subject to low rates of tax, then executors should carefully consider whether each beneficiary should be asked to pay tax, rather than the trustee. In particular where the estate is large and especially where significant assets of the estate are sold in the course of administration and which realise a taxable gain, executors should be particularly diligent.
It makes sense that if a tax-exempt charity receives its share of the deceased’s estate and is not liable for any tax on such share, no tax will be payable on the income relating to the share received.
However for a beneficiary to be liable for tax on the income relating to its share of the estate, the beneficiary must be “presently entitled”. The principles governing present entitlement in the context of deceased estates is set out in Taxation Ruling IT2622. This ruling says that for a beneficiary to be presently entitled to a share of the trust income, the estate must have been “fully administered”. This involves a question of fact. That is, that the assets of the estate have been called in and the deceased’s debts and liabilities have been paid.
Importantly it is the deceased’s debts and liabilities which have to be paid in order to reach full administration, not those of the estate.
Accordingly, even though liabilities incurred in the administration of the estate (such as legal and accounting fees) may not have been paid prior to the making of a distribution of the proceeds of the estate, the relevant beneficiary will still be considered to be presently entitled.
It is common for an executor to sell assets of an estate (such as real estate, investments and shares) and then to make an interim distribution of the proceeds of sale before the executor has even sought confirmation of the taxation liability either of the executor or of the beneficiaries. Capital gains and capital losses made by the estate are aggregated to determine whether the estate has made a net capital gain or a net capital loss. A net capital gain is included in the estate’s net income (Section 95 of the ITAA 1936). Where a resident beneficiary of a trust estate (who is not under a legal disability) is presently entitled to a share of the income of the trust estate, Section 97 of the ITAA 1936 operates to include in the assessable income of the beneficiary, his or her or its share of net income of the trust.
So long as the estate assets have been called in and the deceased’s debts and liabilities have been paid, it does not matter whether or not the estate has reached the point of full administration or is at the intermediate stage. This is because the beneficiaries are presently entitled to any amounts that are actually paid to them by the executor. If the estate has not been finalised it does not prevent the beneficiaries in this situation from being presently entitled to the income actually paid or to be paid to them or on their behalf. However had one or more debts or liabilities of the estate not had been paid prior to any distribution to a beneficiary of his/her/its share of the estate proceeds, the executor would be liable to be assessed on the income of the trust estate under Section 99 or Section 99A of the ITAA 1936.
It is not uncommon in large estates where a significant net capital gain could be derived from the calling in of the deceased’s assets. For example, where the net capital gain was $300,000.00, tax payable by the executor (under Section 99 of the ITAA 1936), the tax would be $108,097.00. If all the beneficiaries were tax exempt charities, no tax would be payable.
In the case where the net capital gain of the trust estate was $15,000.00 and comprised the only income of the estate, in most cases it would be preferable if the executor was assessed under Section 99 of the ITAA 1936 rather than each beneficiary were assessed under Section 97 ITAA 1936, because the net income is below the taxable threshold of $18,200.00 and no tax is payable.
The message for executors is to carefully consider the taxation implications of each estate, which will depend upon the size of the estate, the nature of the assets, the tax position of each of the beneficiaries and whether the debts and liabilities of the deceased have been paid prior to any distribution being made to any of the beneficiaries.