Testamentary Trusts: Tax, Setup and What to Collect

A testamentary trust is a trust created by a will that takes effect after the will-maker dies. Its trustee holds estate assets for the beneficiaries. Your first job is to establish which assets have left estate administration and what the will allows.

What a Testamentary Trust is and When It Comes Into Existence

A testamentary trust arises under the will, but the executor’s administration of the estate and the ongoing trustee’s work are different responsibilities. The will usually contains the trust terms, so there may be no separate trust deed.

During administration, the executor collects assets and pays or provides for estate debts and expenses. The ongoing trust holds the assets allocated to it under the will. Obtain the executor’s transfer records and accounts to establish that handover. A grant of probate alone does not establish that administration is complete.

The ATO’s ruling IT 2622 explains the administration stages and present entitlement. Beneficiaries generally have no present entitlement during the initial stage. Actual income payments during the intermediate stage can create entitlement to the amounts paid. Keep evidence of income earned in each stage when preparing the estate’s final accounts and the trust’s opening balances.

Read the will for the trustee, beneficiaries and any appointor or guardian. An appointor may have power to replace the trustee. A guardian may have consent powers. Neither role exists automatically. The will-maker creates the testamentary arrangement, in place of the settlor who establishes a trust during life.

A family trust established during life normally has a deed and an initial settlement. A testamentary trust receives its authority from the will and its assets through the estate. Keep the deceased estate’s tax returns separate from the ongoing trust’s records.

Discretionary, Fixed and Protective Testamentary Trusts

A discretionary testamentary trust lets the trustee choose beneficiaries’ income or capital allocations within the will’s terms. That flexibility is the reason families use it for changing needs, including children’s education and an adult beneficiary’s circumstances.

A fixed testamentary trust gives beneficiaries defined entitlements. For example, the will might give one beneficiary all income for life and give the capital to another beneficiary afterwards. The trustee cannot replace those rights with a discretionary allocation merely because another result saves tax.

A protective trust places limits on a vulnerable beneficiary’s access to assets. A special disability trust has additional statutory conditions for its beneficiary, purposes and administration. A trust for someone with disability does not automatically qualify. The Department of Social Services explains the requirements for a special disability trust created by a will.

Before the first year-end, read the trust clauses for eligible beneficiaries, income definitions, distribution powers and default entitlements. Use the trust instrument checklist to record the clauses your distribution work depends on. A label on the client’s bank account cannot establish the trust type.

How Testamentary Trust Income is Taxed

Testamentary trust income is generally taxed by reference to beneficiaries’ present entitlement, with the trustee assessed where the law requires it. Present entitlement is a right to income. It does not require the trustee to pay the cash immediately.

An adult resident beneficiary generally includes their share of the trust’s taxable net income in their return. The trustee generally pays tax on a minor beneficiary’s share under section 98. Non-resident beneficiaries also need separate assessment. Income with no presently entitled beneficiary is assessed to the trustee under section 99 or 99A, depending on the circumstances.

Qualifying income allocated to a minor can be excepted trust income under Division 6AA. Ordinary adult rates then apply to that income instead of the special rates for most unearned income of minors. The concession depends on the income’s source, not simply the words testamentary trust in its name. The relevant rule is section 102AG of the Income Tax Assessment Act 1936.

A Child Beneficiary Example

In this hypothetical example, a resident child receives a $10,000 allocation of taxable trust income for the 2026-27 income year. All income comes from qualifying estate assets. The child has no other income, deductions or credits and is not otherwise an excepted person.

At ordinary resident rates, $10,000 falls below the $18,200 tax-free threshold, so income tax is $0. If the whole amount were non-excepted unearned income, tax would be $10,000 multiplied by 45%, or $4,500. These figures exclude Medicare levy. They show the basic tax comparison before any assessment adjustments.

The Income Tax Rates Act’s resident and Division 6AA schedules provide the rates. Moneysmart’s resident tax table confirms the adult threshold. Where section 98 applies, prepare the trustee’s assessment for the child and reconcile any beneficiary return and corresponding credit.

Assets and Annual Returns

An estate asset passing to the testamentary trustee under the will generally does not create an immediate capital gains tax liability. The ATO’s PS LA 2003/12 describes its practice of treating the testamentary trustee like a legal personal representative. A sale to a third party or CGT event K3 can change the result.

Keep the deceased’s acquisition records and cost base, plus date-of-death valuations where required. Pre-CGT assets generally start with that market value. Post-CGT assets generally carry the deceased’s cost base, with exceptions for certain assets such as qualifying dwellings. The transfer value in the estate accounts is not automatically the CGT cost base.

Plan for annual trust accounts and a trust tax return while the income-producing trust continues. Review the lodgement obligation if the trust is inactive or earns no income. The return needs income and deductions, capital gains and losses, beneficiary entitlements and trustee-assessed amounts. Keep franking credits, withholding credits, carried-forward losses and beneficiary identification details with the supporting calculations.

Prepare the trustee’s distribution resolution under the will’s powers. Check the relevant closely held trust reporting and TFN withholding rules separately.

Budget Changes to Testamentary Discretionary Trusts

The enacted minors integrity rule restricts the will-based concession to income traced to the deceased estate’s property or its qualifying accumulations and proceeds. Selling an inherited asset and buying another asset with the proceeds can preserve that connection.

The 2020 amending Act’s application provision identifies which acquisitions and transfers fall under the rule. Apply that boundary to each asset’s records. Adding unrelated property does not make its income excepted merely because the same trustee holds it. Separate the income from estate-derived property and later unrelated contributions.

For example, a trustee invests inherited cash and a later gift from a living relative in one portfolio. Trace the investments and allocate income to each funding source. The relative’s gift does not acquire the estate-derived concession through pooling.

The 2026-27 Budget also proposes a 30% minimum tax on discretionary trusts. Treasury’s later exposure draft announcement excludes deceased estates and discretionary testamentary trusts established for genuine testamentary purposes. This measure is draft legislation, separate from the enacted Division 6AA integrity rule. Do not apply a proposed minimum tax to the current return or treat its proposed exemptions as enacted rights.

Benefits and Disadvantages of a Testamentary Trust

Families use testamentary trusts to manage distributions and keep assets under the will’s terms after estate administration ends. Qualifying allocations to children can use ordinary tax rates. Restricted beneficiary classes can keep capital available to the will-maker’s descendants.

Families also seek protection from a beneficiary’s creditors or relationship breakdown. That outcome depends on the will, control of the trust and the applicable law. A testamentary trust does not guarantee that assets stay beyond a court’s reach.

The ongoing costs include annual accounts, tax returns and trustee administration. Trustees must retain decisions and transaction records. Family provision claims can affect the estate before assets reach the trust. Beneficiaries can also dispute the trustee’s decisions or interpretation of the will.

How Long the Trust Can Continue

The will’s vesting clause and governing law determine when the beneficiaries’ interests must become fixed. Do not assume every Australian testamentary trust has an 80-year maximum.

Jurisdiction	Perpetuity rule to consider
New South Wales	An 80-year statutory period under the Perpetuities Act, subject to its application provisions.
Australian Capital Territory	An 80-year statutory period under the Perpetuities and Accumulations Act.
Victoria	The instrument can select a period of up to 80 years. Otherwise the common-law period applies.
Tasmania	The instrument can select a period of up to 80 years. Otherwise the common-law period applies.
Western Australia	The instrument can select a period of up to 80 years. Otherwise the common-law period applies.
Northern Territory	The statutory default is 80 years, with an instrument able to specify the common-law period.
Queensland	The applicable statutory period is 125 years or a shorter period stated or implied by the trust terms. Earlier dispositions need the transitional rules.
South Australia	The perpetuity rule is abolished. Courts retain powers to order earlier vesting, including provisions concerning 80 years.

The common-law period measures specified lives in being plus 21 years. The will can require earlier vesting than the legal maximum. Ask the estate lawyer to confirm the governing law and the clause’s operation before recording a vesting date. Queensland’s Property Law Act and South Australia’s Law of Property Act explain the main departures from an 80-year assumption.

Whether a will-maker needs a testamentary trust is estate planning work for their lawyer. Your role is to explain the tax consequences and maintain the records for the arrangement the will creates.

How to Set Up a Testamentary Trust After the Will-Maker Dies

After death, the executor administers the estate and transfers the allocated assets to the trustee under the will. Establish the legal authority and asset handover before treating the trust as an operating client.

1. Obtain the will and the grant of probate, or the applicable letters of administration. The estate lawyer handles the grant and any dispute about authority or the trust clauses.
2. Obtain the estate accounts and asset transfer schedule. Record which assets the executor allocates to the trust and when the trustee receives them.
3. Apply for the trust’s own Tax File Number (TFN). The trustee or their authorised tax agent applies. Use the entity TFN application guide to prepare the required information.
4. Assess Australian Business Number (ABN) entitlement. A trustee carrying on an enterprise needs to assess registration for the trust. Mere existence of a testamentary trust does not establish an enterprise or ABN entitlement.
5. Open a bank account in the trustee’s name in that trustee capacity. Keep trust money separate from estate money and the trustee’s personal funds.
6. Prepare opening accounts, asset cost-base records and the annual tax work. Confirm that the opening balances agree with the executor’s transfer records.

The lawyer deals with the will, probate and legal transfers. Your practice deals with tax registrations, accounts and returns under its engagement. Record the estate-to-trust transition so the same income is neither omitted nor returned twice.

What to Collect When a Testamentary Trust Becomes Your Client

Collect the governing documents and the estate-to-trust records before preparing the trust’s registrations or first return. Request a certified copy of the complete will, including codicils and its trust schedules.

File item	What you need to establish
Probate or letters of administration	Who has authority to administer the estate and the terms of the grant.
Variations, court orders and trustee appointments	The current trust terms and the chain to the current trustee.
Individual trustee details	Each trustee’s identity, contact details and authority. Record the identity check and its method.
Corporate trustee details	Company name, ACN, current register information and the identity and authority of its representative.
Beneficiary details	Names, dates of birth, residency and TFNs where required. Flag minors and any legal disability.
Estate asset schedule	Asset description, estate source, transfer date, value and supporting documents. Retain acquisition dates and the deceased’s cost bases where applicable.
Later asset movements	Sales, replacement assets, reinvested income, unrelated contributions and borrowings. Preserve the tracing for excepted trust income.
Trust registrations and banking	The trust’s TFN, ABN where applicable, bank account and authorised contacts.
Prior work	Estate accounts, previous trust returns, distribution records and any outstanding lodgements.

Apply the TPB’s client verification guidance to the trustee and anyone acting for them. A document showing a person’s identity does not establish their authority to instruct you for the trust.

Address the engagement letter to the trustee in their capacity as trustee of the identified testamentary trust. Specify whether your practice also acts for the estate or any beneficiary. Keep those engagements and tax records distinct.

Before starting the first return, reconcile the will, trustee appointments and asset schedule with the client file. You need a supported opening balance and a funding trail for each income-producing asset to apply the minors concession.