Lawyer’s insight to discretionary trusts and the 2026 Budget

Among the measures announced in Labor's 2026 Budget, one of the most consequential for family wealth structures is the proposed minimum tax on discretionary trust income.

Discretionary trusts have long been a cornerstone of wealth management, business structuring and estate planning for hundreds of thousands of Australians. Their appeal comes down to two things:

• flexibility in how income is distributed, and
• the asset protection benefits they can provide.

The proposed reforms would fundamentally change how these trusts are taxed. While the announcement is framed as an income tax measure, its implications may extend well beyond taxation and could affect the way trusts are structured and administered in the future.

It is important to note that only limited details have been released at this stage. The legislation has not yet been published, meaning many important questions remain unanswered. Until the legislation is available, much of the discussion surrounding the reforms remains necessarily speculative.

What is a discretionary trust?

A discretionary trust gets its name from the trustee’s ability to decide how trust income and capital are distributed among beneficiaries.

This is different from a fixed trust, where each beneficiary has a predetermined entitlement set out in the trust deed.

The flexibility provided by a discretionary trust is valuable as it allows trustees to respond to changing family circumstances, financial needs and taxation outcomes from year to year. This flexibility is also closely linked to the asset protection the structure provides.

How does asset protection work in a trust?

One of the principal advantages of a trust structure is that trust assets are generally owned by the trustee, not by the beneficiaries personally. Because beneficiaries of a discretionary trust typically do not have a fixed entitlement to trust assets or future distributions, those assets are less vulnerable to claims against an individual beneficiary. 

This can provide meaningful protection from risks such as creditor claims, bankruptcy and, in some circumstances, family law disputes. It can also be valuable where a beneficiary is financially vulnerable or has demonstrated poor financial judgment. Rather than assets passing directly to that beneficiary, the trustee can consider the beneficiary's circumstances when determining whether distributions should be made.

Asset protection is not absolute. Courts and statutory regimes can, in certain circumstances, look beyond the trust structure, particularly where the person facing a claim exercises substantial control over the trust.

Tax benefits of discretionary trusts

Under the current tax regime, discretionary trusts generally do not pay income tax themselves. Instead, beneficiaries are assessed on trust income distributed to them and pay tax at their own marginal rates.

This allows trustees to allocate income among beneficiaries in a tax-efficient manner. For example, where one spouse earns a high income and other family members have little or no taxable income, trust income may be distributed to those lower-income beneficiaries, reducing the family's overall tax liability.

The benefits can be even more pronounced in the case of testamentary discretionary trusts established under a will. Income distributed from a testamentary trust to minor beneficiaries is generally taxed at ordinary adult marginal rates, whereas distributions to minors from most inter vivos (living) discretionary trusts are subject to penalty tax rates designed to discourage income splitting.

What is the Budget proposing to change? 

Based on the Budget announcement, the Government proposes introducing a 30% minimum tax rate on discretionary trust income from 1 July 2028.

Under the proposed model, the trustee would pay tax at the 30% minimum rate on trust income. Beneficiaries would include any distributions in their own tax returns and receive a tax credit for the tax already paid by the trustee.

The Government has indicated that this credit will be non-refundable. In practical terms, this means a beneficiary can use the credit to reduce their own tax liability, but any excess credit would generally not be refunded.

If implemented as announced, this would substantially reduce the tax advantages currently available through income splitting. The impact may be particularly significant for testamentary discretionary trusts, where income currently can be distributed to minor beneficiaries who are taxed at ordinary adult rates.

However, key questions surrounding the calculation of taxable income, the treatment of capital gains, franking credits, carried-forward losses and the interaction with existing trust taxation provisions cannot be answered until the legislation is released.

Who is exempt?

The Budget announcement indicated that several categories of trust would be exempt from the proposed minimum tax. These include fixed trusts, superannuation funds, special disability trusts, deceased estates and charitable trusts.

For families and private groups, the exemption for fixed trusts is likely to be the most relevant.

A fixed trust is where beneficiaries have predetermined entitlements to income and capital. For example, Beneficiary A receives 50% of trust income, Beneficiary B receives 30% and Beneficiary C receives 20%. At this stage, it’s not clear exactly what the characteristics a trust must possess to qualify as a fixed trust for the purposes of the exemption. It is also unclear whether hybrid structures, such as trusts with fixed income entitlements but discretionary capital distributions, will qualify.

These details will be critical in determining whether existing trust structures can be adapted to access the exemption.

The Fixed Trust exemption – Potential trade-offs

If the exemption is available only to trusts with fixed entitlements, many families may face a difficult choice between preserving tax efficiency and maintaining existing asset protection arrangements.

One of the strengths of a discretionary trust is that no beneficiary has a guaranteed entitlement to future distributions. Fixed entitlements may alter that position and potentially make those interests more visible and accessible in disputes involving creditors, bankruptcy or family law proceedings.

Fixed entitlements may also create difficulties where a beneficiary develops financial, behavioural or addiction-related issues. A trustee who previously had flexibility to manage distributions according to changing circumstances may have fewer options available.

That said, much will depend on the final legislative design. If a trust can qualify for the exemption while retaining discretionary control over capital distributions, a middle ground may emerge. In that scenario, income entitlements could become fixed while the underlying capital assets remain subject to trustee control.

Whether such structures will qualify remains unknown.

Our recommendation: review now, restructure later

At present, our recommendation is clear: avoid significant restructuring until the legislation has been released and properly analysed. Acting before the detail is known risks incurring substantial cost without achieving the intended outcome. 

Once the legislation is available, advisors will be better placed to assess the effectiveness of potential restructuring strategies.

A specific action for wills with testamentary trusts

Estate planning presents a different and more immediate challenge.
Most existing discretionary trust deeds can be amended if changes become necessary. Testamentary trusts established under a will are often less flexible.

A person who loses testamentary capacity before the reforms are finalised may have little or no ability to alter the terms of testamentary trusts contained in their will. As a result, it is prudent to review wills that establish testamentary trusts now, and consider whether they contain sufficient flexibility to respond to future legislative changes.

In particular, consideration should be given to whether the will contains:

• A broad power to vary the terms of the testamentary trust so executors or trustees can respond to future taxation changes and, where possible, access any available exemptions; and
• The ability to bypass the testamentary trust altogether and distribute assets to an alternative structure or directly to beneficiaries if doing so would produce a more favourable outcome.

These provisions can provide valuable flexibility and may assist future trustees and beneficiaries in responding to what could become one of the most significant trust taxation reforms in decades.

 

If you would like to discuss this further, please do not hesitate to contact our office on 03 8517 0150 or you can request a call back.  

 

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.