Who pays tax on estate income?

Correctly identifying who will pay the tax on any income derived by an estate is determined by a number of factors, including if a beneficiary is presently entitled to trust income, under a legal disability or if the estate is fully administered.

Current at 1 November 2021

Who pays tax on estate income?

Correctly identifying who will pay the tax on any income derived by an estate is determined by a number of factors, including if a beneficiary is presently entitled to trust income, under a legal disability or if the estate is fully administered.

Current at 1 November 2021

The Commissioner of Taxation sets out his position on the present entitlement of income during an estate administration in Taxation Ruling IT 2622. This ruling is based upon the High Court findings in FCT v Whiting (1943) 68 CLR 199, where the court held that the beneficiary of a deceased estate cannot be presently entitled to the income of the estate until the estate has been fully administered.

Justices Latham and Williams stated that: “… until an estate has been fully administered by payment or provision for the payment of funeral and testamentary expense, death duties, debts, annuities and legacies and the amount of the residue thereby ascertained, the income of the residuary estate is the income of the executors and not of the residuary beneficiaries.”

In essence, during the estate administration it is not really possible to determine the residual of the estate and accordingly any claim by beneficiaries of either the corpus or income may be defeated by another party lodging a claim against the estate. Hence, the executor is taxed on the income during the administration of the estate.

In IT 2622 the Commissioner establishes three distinct stages of the administration of an estate post the granting of Probate:

StageIncome treatment
Initial stageThe net income of the estate is used to apply to reduce debts such as the testator’s outstanding accounts and funeral expenses etc.
Intermediate stageAt this point, the executor may have identified that part of the estate is not required to pay debts etc. and may decide to pay an interim distribution to beneficiaries.
Final stageAll debts are paid for in full and income is available for distribution to beneficiaries

 

Initial stage

During this stage no beneficiary will be deemed as presently entitled to the income of the estate and accordingly all income must be assessed against the executor. As previously stated, an estate has access to standard adult marginal tax rates for a period of up to three years from date of death. This includes the $18,200 tax free threshold.

Intermediate stage

It is not unusual during the estate administration that an executor may identify that part of the net income of the estate will not be required to meet the estate’s debts and obligations. In these situations, the executor sometimes elects to make an interim distribution to beneficiaries. IT 2622 clearly states that where this occurs, the beneficiaries will be held as presently entitled to the trust income to the extent that is actually paid to them or paid on their behalf.

This could include for example the payment of rent on behalf of a beneficiary in accordance with the terms of a Will.

Final stage

Where an estate has been fully administered, the beneficiaries can be deemed as presently entitled to the income and corpus, as they will be deemed to have an indefeasible and absolute vested interest within the estate. This applies even if the executor has not yet physically transferred all the entitlements to the beneficiaries. Essentially these assets are then deemed to be held on trust on their behalf.

During final year of administration

It has been a long-standing practice of the ATO to permit an apportionment of income between the executor and beneficiaries in the year that the estate is fully administered.

Derived incomeAssessment
Income derived in the period between the beginning of the income year and the day administration was completed.Assessed in the hands of the executor or administrator under section 99 of the Act.
Income derived in the period between the day administration was completed and the end of the income year.Assessed to the beneficiaries presently entitled to the income in the manner require by section 97 or 98 of the Act.

 

Present entitlement is ordinarily determined on the last day of the income year (ie. 30th June) and a beneficiary would ordinarily be assessed on their proportion of trust income for the full financial year. For the above apportionment rules to apply, it is therefore a requirement that adequate evidence of the income derived during these periods is maintained to support how it was apportioned.

The ATO has made it clear that it will not accept income being apportioned merely based on time. It should be noted, that where a beneficiary is under a legal disability, the executor will be assessed on the beneficiary’s share of the trust’s income. Legal disability includes minors, bankrupts and people with legal incapacity due to mental conditions.

 

Download your quick reference guide to who is taxed and when! HERE

 
 

Feel free to contact our team should you want to discuss this topic further and potentially have clients who may be in this situation.

 

 

This publication is not intended to be and should not be used as a substitute for taking taxation advice in any specific situation. The information in this publication may be subject to change as taxation, superannuation and related laws and practices alter frequently and without warning.  Neither BNR Partners Pty Ltd, our employees or agents are responsible for any errors or omissions or any actions taken or not taken on the basis of this publication.