The exemption most wills won't meet
14 October 2026
First published in Substack, October 2026.
Estate planning and testamentary trusts · Legislative and policy commentary
The Government has spared testamentary trusts from its new 30% minimum tax on discretionary trusts. Then it wrote the exemption so that most existing testamentary trust wills won’t meet it.
The Treasury Laws Amendment (Tax Reform No. 3) Bill 2026 was introduced today, Wednesday 14 October. The headline is welcome news for families and for those of us who argued strongly for testamentary trusts to be exempt from the new trust tax regime. The detail is a condition that will catch wills drafted long before anyone contemplated these rules.
The problem isn’t who the trustee actually distributes the money to. It’s who the will allows them to distribute it to.
What the Bill says
From 1 July 2028, trustees of discretionary trusts will pay tax of at least 30% on the trust’s net income. A testamentary trust, created under a will after death, is excluded if it meets three conditions.
1. It was created by a will, a court order or the intestacy rules.
2. Its income comes from assets of the deceased’s estate, or what those assets earn. Assets added from outside the estate after Budget night, 12 May 2026, don’t count.
3. For a trust established on or after 1 July 2028, the will can only allow three categories of beneficiary: individuals, charities and other tax-exempt entities, and special disability trusts.
The first two conditions are sensible. The third is the problem.
Why most wills fail
For decades, testamentary trusts have commonly given trustees a wide class of potential beneficiaries. Alongside children and other family members, the list usually includes family companies, family trusts and sometimes the estate of a beneficiary who has died.
The broad class of potential beneficiaries was included to give trustees flexibility to respond to the family’s changing circumstances. A child might run a business through a company, or set up a trust for their own children. The trustee needs the flexibility to distribute through those structures if the family’s circumstances call for it. The clause sits in the will because it might be useful one day.
The Bill doesn’t care whether it’s ever used. The test looks at who the will allows to benefit from the trust, not who actually receives money. The Explanatory Memorandum is clear on this. One ineligible beneficiary can cost the whole trust its exemption, even if it never receives a dollar.
The timing makes it worse. A testamentary trust is generally established when property passes to the trustee after death, not when the will is signed. A will signed in 2010 can fail a test written in 2026.
And it probably can’t be fixed after death. Once the will-maker has died, the drafting is locked in.
Won’t a power to vary fix it?
Many testamentary trusts include a power to vary their terms. It’s tempting to think the trustee could simply remove the ineligible beneficiaries after death.
In my view, a power to vary is unlikely to cure the problem, and a broad one may make it worse.
1. The test reads the original will. The Bill asks who can benefit under “the instrument establishing the trust”. A later variation doesn’t change the will that established it.
2. The power itself can be the problem. If the trustee can vary the trust to add ineligible beneficiaries, those beneficiaries can still benefit.
3. The anti-avoidance rule. The exemption is denied where income arises from a scheme with a purpose of obtaining it. A variation made after death to qualify sits uncomfortably close to that.
4. The timing. The test applies year by year. Income earned before any variation sits in a trust that failed.
Don’t rely on a power to vary as your way out. The reliable fix is a will that gets the class right before death.
Who pays?
Testamentary trusts exist to look after people. A child who has lost a parent. A surviving spouse. A family member who can’t manage money alone.
Under current law, a child receiving qualifying testamentary trust income is taxed at ordinary adult rates and gets the tax-free threshold, rather than the penalty rates that normally apply to minors’ unearned income. That concession is one reason these trusts are so valuable.
If a trust loses the exemption, the trustee pays the 30% minimum tax and the beneficiary receives a non-refundable offset. Take a child with $20,000 of trust income. At ordinary rates they would pay little or no tax. Under the minimum tax, the trustee pays $6,000. If the child’s own tax is lower, the unused offset is simply lost.
Not every family can fix this with a new will. Someone who has lost capacity can’t redraft. A statutory will is possible, but it means a court application that is slow and expensive. Those families will carry the cost of a drafting convention they had no say in.
We have done this before
The Government’s concern is legitimate. It doesn’t want testamentary trusts used to channel income from unrelated assets to children at concessional rates, or to feed family companies.
Parliament faced a similar problem in 2019. People were putting assets unrelated to the estate into testamentary trusts so income could flow to children at adult rates. The response, s 102AG(2AA) of the Income Tax Assessment Act 1936, limited the concession to income from assets that came from the estate. It applied to assets transferred from 1 July 2019. Not one will had to be rewritten.
The Bill keeps that rule as its second condition, then adds the beneficiary test on top.
One test asks where the money came from. The other asks who could receive it, even if they never do.
There are simpler ways to meet the Government’s objective:
• Tax what happens. Apply the minimum tax to income actually paid to beneficiaries outside the permitted categories, rather than disqualifying the whole trust.
• Grandfather existing wills. Apply the beneficiary test only to wills signed after Budget night. The Bill already uses that date.
• Allow a fix after death. Give trustees a set period to remove ineligible beneficiaries, with safeguards against abuse.
Each would need careful drafting. Any one would protect the revenue without forcing a wave of redrafted estate plans.
What to do now
The Bill has not passed. It is expected to go to a Senate inquiry and may change. I hope this part does.
In the meantime, find your will. If it sets up a testamentary trust, ask your estate planning lawyer to check the class of beneficiaries. Don’t assume it’s safe because it was properly drafted when you signed it, or that a power to vary will fix it later.
The exemption for testamentary trusts is sensible policy. It should work for the families it was written to protect, rather than leave them paying for flexibility built into their wills in good faith.
This article is general information only and is not legal advice.
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