Income-Splitting Through Trusts: Why “Paper” Allocations Aren’t Just Paper

One of the most common tax strategies promoted in New Zealand trusts is income-splitting — where trust income is allocated across several beneficiaries (often adult children) to take advantage of their lower personal tax rates.

It can look smart on paper. But what’s often missed is that allocating income to a beneficiary isn’t just an accounting entry. It creates a real legal entitlement. And that brings with it both obligations and risks.

Allocation = Beneficiary’s Money

When trustees allocate income to a beneficiary in the trust’s financial statements, that amount is recorded as a credit to the beneficiary’s current account. In simple terms, it becomes their money.

Even if no cash is paid out straight away, the trust owes the beneficiary that sum. At some point — whether in the near future, or years later — trustees will need to pay it. It’s not a notional figure the trustees can quietly reverse if it proves inconvenient.

The Trusts Act 2019: Disclosure Is Required

Under the Trusts Act 2019, trustees also have a duty to keep beneficiaries reasonably informed. That includes telling beneficiaries that they are entitled to request basic trust information, such as:

• The fact that they are a beneficiary.

• That they have a current account balance in their name.

• How to request copies of the trust’s financial statements or records.

This means that once income is allocated, trustees should expect that beneficiaries will know about it — and may ask for the money.

The Risks of “Tax-Only” Allocations

Allocating income purely to reduce the trust’s tax bill can have unintended consequences:

• Expectations arise: Beneficiaries may assume distributions will be paid out and start relying on that.

• Family dynamics: One child’s “allocation” can create pressure from others for equal treatment.

• Cashflow strain: Trustees might face financial pressure to pay out balances they never intended to.

• Tax compliance: Beneficiaries may need to file returns for income they’ve technically received — even if no cash has landed in their account.

• IRD scrutiny: The IRD has made it clear it looks at trust distributions that appear designed solely for tax minimisation.

A More Careful Approach

Income-splitting remains a legitimate tool in some cases. But trustees need to remember:

• It’s not just about saving tax — it creates real obligations.

• Allocated income belongs to the beneficiary, and trustees will have to account for it.

• Disclosure is a duty, not a choice. Beneficiaries are entitled to know.

Before making allocation decisions, trustees should step back and ask:

• Does this fit with the trust’s purpose?

• Can the trust actually pay this out in the future?

• Are we comfortable with the beneficiary knowing they’re entitled to these funds?

The Bottom Line

What looks like a simple way to lower tax can end up creating expectations, obligations, and potential disputes. Trustees need to treat income allocations as what they are — the beneficiary’s money — and be prepared to pay and disclose accordingly.

In trust administration, the safest savings are often the ones that don’t create bigger costs down the line.