Planning for one’s death is not something that most people are comfortable talking about, but having a decent understanding of what falls within your estate, or even knowing how your beneficiaries can potentially get taxed on their inheritances, may go a long way in setting up a plan for your wealth. If you are one of the many migrants who moved to Australia and have foreign assets or structures, this becomes even more important to ensure you are passing on your estate in a tax efficient manner, not only in Australia but the foreign jurisdiction as well.
Luckily, we don’t have inheritances taxes in Australia; however, we do have various provisions within our legislation that detail the implications of inheriting assets from a deceased person.
Case Study
Lucille is 54 years of age and has significant wealth, which she acquired over the years. She has the following assets:
- $1.5 million in a term deposit
- A residential property worth $1.5 million which she originally acquired for $500,000
- A rental property worth $1.5 million which she originally acquired for $500,000
- $1.5 million in her superannuation fund
She has four children (Michael, Lindsay, Tobias and Buster) and for ease of administration, decides that she will bequeath one asset each to her children since the values are the same and she believes it is equitable to do so.
Michael – Inheriting the amount from the term deposit
There are no tax issues for Michael. He can walk away with the $1.5m in cash and use the funds at his discretion.
Lindsay – inheriting the main residence
Again, a positive outcome for Lindsay. If the property is Lucille’s main residence at the time of death, Lindsay will be deemed to have acquired it at market value on date of death; furthermore, if the property is disposed of within two years of date of death no capital gains tax (CGT) will be payable in Australia. If Lindsay decides to use the property as her main residence, she will have continued access to the main residence exemption. Alternatively, if Lindsay rents the property out and sells it after a few years, she will only be liable for CGT on the movement in value from date of death – i.e. the $1m increase in value since date of acquisition to date of death is essentially ignored for tax purposes.
Tobias – inheriting the rental property
Tobias will be a bit hard done by as he will have inherited a rental property and will also inherit Lucille’s cost base of $500,000. If Tobias uses the property as his main residence, he will be entitled to a partial main residence exemption eventually, but he would be liable for tax on that sale. If Tobias decides to sell the property, he will have to pay CGT on the $1,000,000 gain that would equate to around $235,000, assuming the highest marginal tax rate and taking into account the CGT discount. Essentially, Tobias has walked away with $1.265m as opposed to Michael and Lindsay who walked away with $1.5 million.
Buster – inherited Lucille’s superannuation fund balance
Death benefits paid to dependants (spouses, children under 18 etc.) are taxed concessionally; however, assuming Buster is over 18, he would not be considered a dependant. The lump sum payment from the superannuation fund could be taxed at 17% or 32% depending on the taxable and untaxed components of the superannuation fund. Buster could pay anywhere between $255,000 and $480,000 in tax on his inheritance. Like Tobias, he would probably not appreciate receiving less than their other two siblings.
Something else Lucille should be considering on an ongoing basis is ensuring she has made appropriate binding death nominations and planned for her superannuation effectively. There have been a series of cases where another person has accessed a deceased person’s superannuation balance even though that was not the original intention due to poor planning and not making nominations.
Forget about the tax – what else should Lucille be considering?
The above example mainly focused on how the kids will be taxed but although tax is inevitable, like death, there are other issues to consider. This could include protecting her children from instances such as alcohol or drug problems, potential liabilities, failing relationships and more unforeseen circumstances. Testamentary trusts can be useful in these situations where a trust is created by a Will. Instead of the assets being distributed to the beneficiaries, they are retained in a trust for the benefit of the beneficiaries. The use of a testamentary trust allows the benefits of a discretionary trust for both income and capital upon the death of a person. Usually, the Will would specify which assets would be transferred to the testamentary trust. No CGT arises on the transfer of assets to the testamentary trust, and it is useful from an asset protection point of view where there may be potential claims against a beneficiary, such as claims from creditors or spouses in the event of a relationship breakdown. Income distributions to minors are also taxed concessionally from income generated on assets transferred to the trust by the Will.
Lucille should also have clarity on what assets fall within her estate and those that fall outside her estate. For example, if she owned the main residence as joint tenants with her sister, the property wouldn’t fall within the estate and her sister would acquire the remaining 50% of the property on Lucille’s death; however, if she owned the property as tenants in common, the property would fall within her estate and her share of the property can be passed down to her children.
Furthermore, if any of the kids are non-residents of Australia, this could create further headaches for them because they not only have limited access to things like the main residence exemption, 50% CGT discount etc., but they also need to consider the implications of receiving the amount in the foreign jurisdiction – unlike Australia, a lot of other countries do levy inheritance taxes.
Concluding thoughts
The above is an example with a very simple set of assets and the issues that may arise can become a lot more complex when you are dealing with multi-generational businesses and sophisticated structures.
We routinely work with lawyers to ensure our clients have considered the various issues and options available to ensure their wealth is protected and passed down in an effective manner to the next generation.