The new trust tax and testamentary trusts: why most families have little to worry about

Treasury has released the exposure draft legislation for the proposed 30% minimum tax on discretionary trusts. The question estate planners have been waiting to answer is whether testamentary trusts remain protected, and if so, on what conditions. The answer is reassuring.

Testamentary trusts have long been one of the most effective tools available for protecting inherited wealth and managing it tax-effectively across generations. If they were swept into the new regime, the consequences for Australian families would have been significant.

The concern became so widespread that on 18 June 2026 Prime Minister Anthony Albanese and Treasurer Jim Chalmers publicly announced that genuine testamentary trusts would be exempt from the new tax and promised further detail on how that exemption would work. Treasury has now released the exposure draft legislation and we can finally see how that promise is intended to be delivered.

The tax itself is simpler than it sounds. When a discretionary trust distributes income to a beneficiary, the trust may be required to pay a minimum 30% tax on that amount. Whoever receives the income is still taxed at their own marginal rate but receives a credit for the tax already paid by the trust. If their own rate is below 30%, there is no refund, and 30% becomes the floor. In plain English, the taxman wants trust income taxed a bit more like a wage.

Not all discretionary trusts are the same. The proposed tax is primarily aimed at the family trusts people establish during their lifetime to hold investments or run businesses. Estate planning lawyers call these inter vivos trusts because they are created between living people. A testamentary trust is different. It does not exist during your lifetime at all. It is created by your will and only comes into existence after your death.

A testamentary trust is a discretionary trust that springs to life under your will when you die. It only exists if you have deliberately drafted your will to include one for your beneficiaries, which is exactly what tax-smart, asset-protective estate planning does. For decades they have been the gold standard for protecting inherited wealth and managing it tax-effectively across generations. People use them for two very good reasons. They shield an inheritance if a child hits a rough patch, a bankruptcy or a divorce, and they let income be shared with young children and grandchildren at ordinary adult tax rates instead of the eye-watering penalty rates that normally apply to children.

Deceased estates and special disability trusts are carved out of the new tax outright. They are simply not caught, full stop.

A testamentary trust is different. It technically falls within the framework of the new rules, but in my view Treasury has come up with an elegant solution. Rather than inventing an entirely new exemption regime, it has reached for an old friend: the excepted trust income rules in section 102AG of the Income Tax Assessment Act 1936.

Those are the same rules that have shielded children's inheritances from penalty tax for decades. Treasury has effectively taken a framework that advisers and estate planning lawyers already understand and given it a new job. Instead of determining whether a child receives adult tax rates, the rules now help determine whether testamentary trust income is protected from the new minimum trust tax.

Same machinery, a new job.

The protection does not come from testamentary trusts being waved through at the door. It comes from a familiar set of rules doing what they have always done.

The conditions are relatively straightforward.

First, the trust must arise under a will, an intestacy or a court order relating to a deceased estate.

Secondly, the income must be derived from assets that came from the deceased estate, or assets acquired with those estate assets.

Thirdly, for testamentary trusts that come into existence on or after 1 July 2028, the income must ultimately be distributed to an individual or a tax-exempt entity such as a charity. The Government announced this qualification when it unveiled the exemption on 18 June 2026 and it now appears in the exposure draft legislation.

The focus is not on the capital you leave behind. It is on where the income generated by that capital ends up. If a testamentary trust holds estate assets and distributes its income to children or grandchildren, you have met those requirements as a matter of course.

You are also not locked into holding the original assets. Leave a rental property, have the trustee sell it and buy shares, and the income from those shares can still qualify. The exception follows the estate wealth as it is reinvested, allowing trustees to manage investments sensibly without losing the benefit.

The friendliest feature is that all of this is tested income by income, not trust by trust. The legislation does not ask one big yes-or-no question about the entire trust. It looks at particular amounts of income and whether those amounts satisfy the requirements.

That means a trust can have some income that qualifies and some that does not in the same year. Only the income that misses the requirements is exposed.

Picture a trust that distributes most of its income to grandchildren but directs a small amount to a family company. The grandchildren's share may qualify for the exception. The company's share may not.

The rules are more nuanced than many people assume. A non-qualifying distribution does not necessarily contaminate the entire trust.

Two things call for a deliberate decision.

The first issue is the use of non-individual beneficiaries.

For testamentary trusts established on or after 1 July 2028, trust income generally needs to be distributed to individuals or tax-exempt entities if the exemption is to apply. As a result, any testamentary trust that may distribute income to a company, another trust or another non-individual beneficiary deserves a closer look.

The precise scope of this restriction remains uncertain. The operative provision focuses on the beneficiary that actually receives the income, which suggests that the mere existence of a broad beneficiary class may not, of itself, jeopardise the exemption. On that reading, the concern arises only where income is in fact distributed to a company or another trust.

However, the Explanatory Memorandum uses broader language and could be read as saying that companies and trusts cannot be beneficiaries at all. If that is right, this issue becomes much more significant. Many testamentary trust wills currently in use include companies and trusts within the beneficiary class as a matter of routine drafting. In that case, many wills may need to be reviewed and amended to preserve access to the exemption. Until the position is clarified, caution is warranted.

The second issue is ensuring that the testamentary trust remains a genuine vehicle for holding estate assets and assets derived from those estate assets through reinvestment.

The exception is designed for inherited wealth and what that wealth grows into. Injecting unrelated assets into a testamentary trust simply to shelter their income is precisely the type of arrangement the integrity rules are designed to address.

So where does that leave the average family?

Calmly placed.

If you have a testamentary trust, or you are thinking about one, it will almost certainly continue doing what it was designed to do. The rules sound technical, but they largely describe what a genuine testamentary trust already looks like: created under a will, holding estate assets and distributing income to family members.

The real significance of Treasury's approach is that it has not attempted to reinvent the wheel. By building on the existing section 102AG framework, it has produced a solution that is both familiar and workable.

There is a larger point here. The Government has examined discretionary trusts closely, decided that testamentary trusts are worth protecting. The reform reaffirms testamentary trusts as one of the most tax-effective and asset-protected ways to pass wealth to the next generation.

So if your will does not include one, this is a sensible moment to ask whether it should. A well-drafted testamentary trust can be the difference between an inheritance that is exposed to a beneficiary's creditors, a divorce or unnecessary tax, and one that is shielded and passed on efficiently. The new rules leave that advantage firmly intact.

The draft is still open for consultation and the detail will evolve. But the overall shape is now clear, and the direction is encouraging. The Government has taken a close look at discretionary trusts and, in doing so, has largely confirmed what estate planners have long understood: testamentary trusts remain one of the most effective ways to protect inherited wealth and pass it on across generations.

This article is general information only and does not take account of your personal circumstances. It is not legal, tax or financial advice, and you should obtain advice specific to your situation before acting. The legislation discussed is in exposure draft form and may change.