Income from a genuine testamentary trust is generally taxed at individual marginal rates, including the tax-free threshold, when that income traces back to deceased estate assets. The Government has flagged an exemption for genuine testamentary trusts from its proposed 30% minimum tax on discretionary trusts, but this depends on final legislation and strict tracing rules. Review your trust deed now and get tailored advice before assuming your structure is protected.
TL;DR:
- Genuine testamentary trusts will likely be exempt from the upcoming 30% minimum trust tax if income can be traced back to estate assets, subject to final legislation.
- Maintaining detailed records from the time probate is granted is essential to prove the origin of estate income and preserve concessional tax treatment for minors.
- From the fourth income year onward, the estate is taxed under less favorable deceased-estate trustee rates unless income is properly distributed to beneficiaries.
- The new rules will restrict exemptions if deeds allow companies or other taxable entities as beneficiaries, emphasizing the importance of reviewing trust deed wording.
- Getting legal advice now can help ensure beneficiary classes are broad enough and tracing records are sufficient to protect estate tax benefits before 2028 changes take effect.
Table of Contents
- Testamentary trust tax rates: the current ATO framework
- Excepted income and why tracing determines your tax outcome
- How minor beneficiaries are taxed differently
- Trustee duties: TFNs, tax returns, Medicare levy and offsets
- What the 2026 Budget reforms mean for testamentary trusts
- Getting legal advice before you assume you’re covered
- Funding Your Legal Matter — No Win, No Fee
- Key takeaways and what to do next
- Sources
- FAQ
Testamentary trust tax rates: the current ATO framework
For the first three income years, a deceased estate gets concessional treatment. The ATO applies the same rate scale used for individuals, tax-free threshold included, to income the estate hasn’t yet distributed. That’s a genuine concession: an estate holding rental property or term deposits pays nothing on the first slice of income, the same as a working individual would.
After several income years, if the estate is still administered, the trustee is taxed under separate deceased-estate trustee tax rate tables, which are less generous than the individual scale. This encourages executors to finalise estates reasonably promptly.
Once income is properly distributed to a beneficiary who’s presently entitled to it, the tax obligation usually shifts to that beneficiary, taxed at their own marginal rate. If income is retained by the trustee rather than distributed, the trustee pays tax on it instead, often at a less favourable rate.
| Scenario | Who pays | Rate basis |
|---|---|---|
| First 3 years, undistributed estate income | Trustee | Individual rates, tax-free threshold applies |
| Year 4 onwards, estate still open | Trustee | Deceased-estate trustee tables (less concessional) |
| Income distributed to an adult beneficiary | Beneficiary | Beneficiary’s own marginal rate |
| Excepted income distributed to a minor | Beneficiary (via trustee assessment) | Normal adult individual rates |
| Non-excepted income to a minor | Trustee, on behalf of minor | Higher penalty rates |
Which row applies to your family usually comes down to one thing: whether the income counts as excepted income under the tracing rules, covered next.
Excepted income and why tracing determines your tax outcome
Excepted income is income that genuinely flows from deceased estate property, things like rent from an inherited house, dividends from inherited shares, interest on estate cash, superannuation death benefits, or compensation payments received because of the death. This category gets the concessional adult-rate treatment under ATO guidance on income for people under 18, even when the beneficiary is a child.
Tracing is the test that decides whether income keeps that status. Sell an inherited property and reinvest the proceeds, and the replacement asset generally carries the concession forward, provided you can prove the money’s origin. Break that chain and you lose the benefit.
Common mistakes that destroy tracing:
- Mixing estate funds with a separate family trust or personal account
- Reinvesting proceeds without keeping settlement statements or bank records
- Assuming verbal record of the source will be enough if the ATO asks
- Adding new capital to the trust from unrelated income streams
Pro Tip: Keep a dedicated ledger for every estate asset from the day probate is granted, showing what was sold, when, and where the proceeds landed. Executors who skip this step often can’t reconstruct it years later when it matters most.
How minor beneficiaries are taxed differently
Income paid to a minor from most trusts attracts penalty rates designed to stop parents shifting personal income to children’s names for tax purposes. Those rates bite hard and fast, unlike the gradual individual scale.
Testamentary trusts get a specific carve-out. Where the income is excepted, meaning it traces back to the deceased estate, a minor beneficiary is taxed as if they were an adult, tax-free threshold and all. The ATO’s Appendix 10 rate tables set out exactly how trustees calculate this.
In practice, this means a grandchild receiving excepted income from a testamentary trust can receive income up to the individual tax-free threshold with no tax payable, something a family trust distribution to the same child could never achieve.
To protect this treatment, trustees should keep:
- Records tracing every dollar of income back to a specific estate asset
- Copies of the will and trust deed showing the testamentary trust was properly established
- Annual distribution statements naming each minor beneficiary and the income source
Trustee duties: TFNs, tax returns, Medicare levy and offsets
Running a deceased estate or testamentary trust comes with real paperwork, and getting it wrong causes reporting errors that can cost the family concessions later.
- Apply for a trust TFN as soon as probate is granted or letters of administration issue, separate from the deceased’s personal TFN.
- Get an ABN too, if the trustee is continuing to run a business the deceased owned, alongside the trust TFN, following ATO instructions for trustees.
- Report all estate income received after death, rent, interest, dividends, business income, on the trust tax return, regardless of whether it’s later distributed.
- Work out who pays: the trustee pays on undistributed income; beneficiaries pay on amounts they’re presently entitled to.
- Apply Medicare levy and offsets correctly, since deceased-estate income can attract levy exemptions and low-income offsets depending on how it’s assessed.
Executors frequently blur the line between the deceased estate and the testamentary trust it might fund, treating them as one entity for tax purposes. They aren’t. Each needs its own correct registration and its own return where required.
What the 2026 Budget reforms mean for testamentary trusts
The Government’s proposed changes are significant, and they explain why this topic is suddenly urgent for anyone with a will trust already in place. The Budget factsheet on minimum tax for discretionary trusts outlines a 30% minimum tax on discretionary trust income from 1 July 2028, with a 30% minimum on net capital gains applying from 1 July 2027. Trustees would receive credits reflecting tax already paid at trustee level, avoiding pure double taxation.
Crucially, the factsheet flags an exclusion for genuine testamentary trusts, but the conditions attached matter enormously.
- Income likely must still trace cleanly back to deceased estate assets to qualify for the carve-out
- Deeds drafted from 1 July 2028 onwards may need to restrict beneficiaries to individuals and tax-exempt entities only
- A deed that permits companies or other taxable trusts as potential beneficiaries could disqualify the exemption, according to analysis from Firstlinks, even if no distribution to them ever happens
Don’t restructure in a panic. Independent commentary from Morningstar Australia suggests modelling worst-case scenarios against your existing deed is far more useful right now than rewriting it before the legislation is settled. If you’re weighing up a simple will against a full testamentary trust structure, factor these pending rules into that decision, not just current settings.
Getting legal advice before you assume you’re covered
A lawyer reviewing your will trust checks three things: whether the beneficiary class is drafted broadly enough to risk the exemption, whether the deed supports clean tracing of estate assets, and whether the structure still achieves its original purpose. Financial planning research on testamentary trusts notes that income splitting is often a secondary benefit, asset protection is usually why the trust exists in the first place, so tax changes shouldn’t drive you to undo that protection.
Expect your lawyer to ask for:
- The current will and trust deed
- Estate asset records and any sale or reinvestment documentation
- Details of intended beneficiaries, including minors
If you haven’t reviewed your testamentary trust versus family trust structure since the Budget announcement, now’s the time.
Funding Your Legal Matter — No Win, No Fee
Legal costs shouldn’t stop someone with a genuine claim from getting proper advice. Simons George Legal offers No Win, No Fee arrangements for eligible matters, including contested estate and inheritance disputes, so cost isn’t the barrier standing between you and pursuing what you’re entitled to.
Eligibility gets assessed during a free initial consultation, where we look at the facts of your situation before any commitment is made on either side. If your matter qualifies, you can move forward knowing legal fees aren’t due unless the outcome favours you.
Book a free case assessment through Simons George Legal’s wills and estates page to find out where you stand.
No Win, No Fee arrangements are subject to case eligibility and a written costs agreement. Liability limited by a scheme approved under Professional Standards Legislation.
Key takeaways and what to do next
Testamentary trust income tied to deceased estate assets is generally taxed at individual marginal rates, and genuine testamentary trusts are expected to sit outside the proposed 30% minimum trust tax, once legislation is finalised.
Three things to do now: review your trust deed for beneficiary class wording, tighten up your tracing records for every estate asset, and get advice before the 2028 rules lock in. Don’t restructure prematurely while consultation is ongoing. For a deed review, contact Simons George Legal.
This article is general information, not a substitute for advice from a qualified financial advisor. Consult a qualified financial professional about your own circumstances before acting on anything here.
Sources
- Tax rates for deceased estates (ATO)
- Tax explainers — minimum tax on discretionary trusts (Government Budget factsheet)
- Testamentary trusts and the 2026 Budget (Hudson Financial Planning)
FAQ
Will testamentary trust tax rates change in 2026?
Not immediately. The proposed 30% minimum tax on discretionary trusts doesn’t start until 1 July 2028, with capital gains changes from 1 July 2027, and genuine testamentary trusts are expected to be exempt subject to final legislation.
How can a testamentary trust reduce tax for a family?
By splitting excepted income, income traced to deceased estate assets, among multiple beneficiaries, including minors, who can each access the individual tax-free threshold instead of one person paying tax at a higher marginal rate.
What are the disadvantages of a testamentary trust in Australia?
Ongoing compliance costs, the need for a separate TFN and annual trust tax return, and the risk of losing concessional tax treatment if tracing records aren’t kept properly are the main drawbacks.
How does the proposed 30% minimum tax on trusts work?
Trustees would pay a minimum 30% on discretionary trust income from 1 July 2028, receiving credits for tax already paid at trustee level, with exclusions proposed for genuine testamentary trusts meeting tracing and beneficiary-class conditions.