Family Trust Elections: Tax Utility, Risk and Family Law Implications

Without that level of expertise, parties risk achieving a superficially “equal” division of assets that is in reality, significantly eroded by avoidable tax liabilities.

What is a Family Trust Election (FTE)

An FTE is a formal election made to the Australian Taxation Office which designates a trust as a “family trust” for tax purposes. The election nominates a “test individual,” and defines a “family group” around that individual, which then governs who can receive distributions without adverse tax consequences.

Once an FTE is made, it can only be varied or revoked in very limited circumstances.

FTEs and Family Law

In the family law context, these constraints become particularly acute. Separation or divorce can fracture the “family group,” creating significant tax exposure if not carefully managed. The increasing willingness of the ATO to enforce Family Trust Distribution Tax (FTDT) liabilities underscores the importance of integrating tax structuring—particularly the use of interposed entity election (IEEs)—into any property settlement involving family trusts.

Why Separation or Divorce Creates Risk

In practice, this creates a tension in property settlements: the family law objective of dividing assets may conflict with the tax constraints imposed by an FTE. Where distributions are contemplated as part of a settlement outcome, failure to consider the operation of the FTE may result in a significant and unintended tax liability arising for the recipient spouse, effectively eroding the value of the property division achieved.

Family Law events—particularly separation and divorce—can fundamentally disrupt the assumptions underpinning an FTE.

For example:

• New partners or entities introduced as part of a property settlement (such as newly established trusts or companies) will generally fall outside the family group unless specific steps are taken.
• Distributions made as part of implementing a property settlement—particularly where they involve new entities or restructured interests—may inadvertently trigger FTDT if they fall outside the defined group.
• Relevant advisers may not be sufficiently aware of the existence or implications of an FTE.

What an FTE Does and Why it is Used

The principal purpose of an FTE is to unlock specific tax concessions otherwise unavailable to discretionary trusts. These include the ability to utilise prior-year tax losses and to stream franking credits to beneficiaries in a tax-effective manner.

In a standard discretionary trust, the trustee has broad flexibility to distribute income to a wide class of beneficiaries. However, once an FTE is made, that flexibility is deliberately constrained: distributions must be made only within the defined “family group,” failing which punitive tax consequences arise.

The tax minimisation strategy is therefore one of controlled flexibility: the trust sacrifices breadth of distribution in exchange for access to concessional tax treatment and certainty in income streaming.

The “Family Group” and Permissible Beneficiaries

The “family group” is broadly defined around the test individual and includes:

• The individual and their spouse
• Children, grandchildren and lineal descendants
• Certain related entities (companies or trusts) that have made interposed entity elections
• In some circumstances, former spouses and widows/widowers

Distributions within this group are tax-effective because they avoid the imposition of FTDT. By contrast, distributions outside the group trigger FTDT at the top marginal rate (currently 47%), which is effectively a penalty tax.

The risk: FTDT and ATO Enforcement

FTEs in Practice

Recent authority highlights the rigidity of the Family Trust Distribution Tax regime. In Deputy Commissioner of Taxation v Widdup (No 2), the Federal Court confirmed that liabilities arising from trust distributions will be enforced according to the statutory framework, even where the outcome is unintended.

This rigidity is now the subject of current Federal Court litigation involving the Thomas family (associated with Thomas Foods International) (as at April 2026). The proceedings arise from a substantial FTDT assessment (reported to be in excess of $13 million including interest and penalties) triggered by an error in the making of an FTE. In that matter, the wrong “test individual” was nominated when the election was made, with the consequence that distributions made to entities and individuals assumed to be within the relevant family group were, as a matter of law, outside the defined group.

The error remained latent for a number of years and only crystallised upon later restructuring, at which point the ATO assessed FTDT on the historical distributions.

Critically, the taxpayer has sought to challenge the assessment and the Commissioner’s refusal to allow any effective correction of the election, bringing into sharp focus whether there is any capacity—through statutory construction, administrative law principles or otherwise—to obtain relief from what is, in substance, a technical defect with severe financial consequences. As at the time of writing, that matter remains before the Court and no final judgment has been delivered.

The case is being closely watched because it squarely tests the proposition that the FTE regime admits of no flexibility once an error is made, even where the commercial reality is that distributions were intended to remain within a single economic family.

The Role of Interposed Entity Elections (IEEs)

An interposed entity election (IEE) is a critical tool in managing this tension. An IEE effectively brings a company or trust within the “family group” for FTE purposes, allowing distributions to flow through that entity without triggering FTDT.

In a Family Law context, IEEs can be used to:

• Facilitate distributions to newly created entities as part of a property settlement
• Preserve tax efficiency when restructuring trust interests between parties
• Avoid inadvertent FTDT liabilities when implementing orders or agreements

However, IEEs must be carefully timed and correctly documented. Failure to do so can result in irreversible tax consequences.

FTEs are a powerful but rigid tax planning mechanism. While they enable tax minimisation, they impose strict constraints on who can benefit from trust distributions.

Family Law events—particularly separation and divorce—can fundamentally disrupt the assumptions underpinning an FTE and it requires an experienced Family Lawyer collaborating with an Accountant and other advisers to ensure that legal integrity and tax efficiencies are preserved during a property settlement.