Discretionary Trusts and Income Splitting: The Legal Loophole Costing Billions

What's a Discretionary Trust, and Why Should You Care?

Most Australians have never set up a discretionary trust. But there's a good chance you're subsidising the ones who have.

A discretionary trust is a legal structure - widely used by wealthy families, professionals, and small business owners - that allows income to be distributed to multiple family members at the trustee's discretion. The critical word there is discretion. The person controlling the trust decides, each financial year, how much income each family member receives.

On its own, that sounds innocent enough. The problem is how it interacts with Australia's progressive tax system - and the result is one of the most expensive and least-discussed tax concessions in the country.

How the Splitting Works

Here's a simple example. Say a self-employed accountant earns $300,000 through a discretionary trust. Instead of paying tax on that $300,000 themselves - which would attract the top marginal rate of 45% on income above $180,000 - they distribute it across their spouse and two adult children.

Each person receives $75,000. Each pays tax at a much lower marginal rate. The family's total tax bill drops dramatically - potentially saving tens of thousands of dollars per year compared to what a salaried employee earning the same income would pay.

The salaried employee has no choice about how their income is assessed. The trust owner does. That's the loophole.

The Numbers Are Staggering

This isn't a niche arrangement. Australia has one of the highest rates of trust usage in the world:

• There are approximately 800,000 discretionary trusts operating in Australia
• They collectively hold an estimated $3.2 trillion in assets
• The Australian Treasury has estimated the tax concession from income splitting through trusts costs the federal budget roughly $3.5 billion per year
• Independent economists, including researchers at the Australia Institute, have put the true cost even higher when accounting for broader wealth sheltering strategies

To put $3.5 billion in context: that's more than the federal government spends annually on social housing assistance. It's nearly double the annual budget of the Australian Securities and Investments Commission.

Who Benefits - and Who Doesn't

This is fundamentally a tax concession for people wealthy enough to have a trust structure in the first place. Setting up and maintaining a discretionary trust requires legal advice, accounting fees, and enough income or assets to make it worthwhile.

The result is a two-tier tax system: one for people who receive a salary, and another for people with the wealth and professional advice to structure their income differently. Both groups may earn the same amount - but they don't pay the same tax.

Why Does This Policy Still Exist?

The short answer: political will, not legal complexity.

There's nothing technically difficult about reforming trust taxation. The Henry Tax Review in 2010 recommended changes to trust tax rules. Treasury has repeatedly flagged the inequity. Yet successive governments - Labor and Coalition alike - have done almost nothing.

Why? Because the beneficiaries of this arrangement are disproportionately influential. They tend to be:

• High-income professionals (lawyers, doctors, accountants - the very people who advise on tax law)
• Small business owners and farmers, who form important voting blocs in marginal seats
• Donors to major political parties

The Coalition has historically defended trust structures as essential for small business and farming families. Labor, despite promising reform in opposition, has consistently backed away from it in government - the 2019 federal election saw Labor propose modest trust reforms, and the backlash was fierce enough that the policy was quietly shelved after their defeat.

Both parties have made a calculated decision: the noise from those who benefit outweighs the silence of those who are quietly overcharged.

The Fairness Problem

This goes beyond dollars. It's a question of what kind of tax system we want.

Australia's progressive income tax is built on a simple principle: those who earn more contribute more. Discretionary trust income splitting undermines that principle directly. A family in the top income bracket can, with the right professional advice, structure their affairs so that no individual member ever appears to be in the top bracket at all.

Meanwhile, a nurse earning $90,000 pays every cent of their marginal rate with no flexibility whatsoever. Their income cannot be split. Their tax cannot be minimised this way. They simply pay.

That asymmetry - legal, entrenched, and expensive - is a policy choice. And it's a choice that's been made repeatedly by governments of both stripes, without ever being put to the Australian people directly.

What Would Voters Choose?

Polling consistently shows Australians support a fairer tax system and are concerned about wealth inequality. A 2023 Australia Institute survey found that more than 70% of Australians believe high-income earners use legal loopholes to avoid paying their fair share - and that the government should close them.

But wanting something and being able to vote for it are two different things. When both major parties protect the same loophole, voters have no real choice at the ballot box.

This is exactly the kind of policy that direct democracy exists to fix. When members of the public - not party donors, not well-connected professionals, not lobbyists - get a direct say on tax policy, the calculus changes entirely. The people who benefit from trust income splitting are a small minority. The people subsidising them are everyone else.

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Think Australia's tax system should treat everyone equally - regardless of whether they can afford a trust structure? So do we. Direct Democracy gives everyday Australians a real vote on real policy - not just a choice between two parties that agree on the things that matter most to their donors.

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