Who Pays Tax on Estate Income in Australia?

What Is Estate Income?

Estate income is income derived by the assets of a deceased estate after the date of death and before the estate is fully administered and distributed. Typical examples are:

• interest credited to bank or term deposit accounts;
• dividends paid on shares with a record date after the date of death;
• distributions from managed funds and unit trusts;
• rent received from estate-owned residential or commercial property;
• distributions from family trusts and partnerships;
• net business income where the estate continues a business briefly during administration; and
• capital gains on the sale of estate assets during administration.

Estate income is conceptually different from income of the deceased, which is income derived up to the date of death and is reported in the deceased's final personal return (the 'date-of-death return'). It is also different from the corpus of the estate — the underlying assets that make up the residue.

The Administration Period

The administration period runs from the date of death until the estate is fully administered. The ATO and the courts treat 'fully administered' as the point at which the executor has collected the assets, paid the debts (including taxes and funeral expenses) and ascertained the residue — so that the beneficiaries' shares are calculable and capable of being paid. For most estates that require probate, the administration period is several months; for complex estates with business assets or disputes, it can be years.

During the administration period, the executor (or administrator) holds the assets as trustee of a trust estate. The estate is treated as a trust for income tax purposes — but it is taxed under a special set of rules that recognise the particular features of estate administration. The starting points are Division 6 of Part III of the Income Tax Assessment Act 1936 (Cth) — in particular sections 97, 98, 99 and 99A.

The executor's broader duties during this period are covered in our companion article on executor duties in Victoria; the basic process for obtaining probate is covered in probate in Victoria and (where there is no will) letters of administration in Victoria.

Estate Taxation Basics

The Australian income tax system has no separate 'inheritance tax'. The estate itself does not pay tax on the value of assets it receives — death is not a CGT event. What is taxed is income: the income that the estate's assets generate during administration, and capital gains on later disposals of estate assets. There are three possible taxpayers for any item of estate income:

• the deceased, in the date-of-death return, for income up to the date of death;
• a beneficiary, where the beneficiary is presently entitled to a share of the net income; or
• the trustee (the executor), where no beneficiary is presently entitled, or where the beneficiary is under a legal disability or the income has been accumulated.

The challenge during administration is identifying which rule applies to which item of income, in which year.

The Executor's Tax Responsibilities

From a tax point of view, the executor is responsible for:

• notifying the ATO of the death and obtaining an estate Tax File Number;
• finalising the deceased's tax affairs — the date-of-death return and any outstanding prior-year returns;
• identifying every source of estate income;
• lodging the estate's trust tax return for each income year of administration;
• deciding (with advice) how income is to be streamed or accumulated;
• issuing distribution statements to beneficiaries who are presently entitled;
• paying any tax assessed to the trustee;
• handling franking credits, foreign income and CGT events; and
• keeping records sufficient to support every position taken in the estate return.

The executor is personally liable for the proper administration of the estate, including the proper handling of its tax affairs. That personal liability is a very good reason to obtain accounting advice early and to keep it engaged throughout administration. Executors considering whether they should be paid for that work should read our note on executor commission and remuneration.

The Estate Income Tax Return

The estate lodges a trust tax return for each income year during the administration period. The return reports the estate's assessable income, its allowable deductions and its net income. It then shows how the net income is taxed — what portion is streamed to beneficiaries presently entitled (and is therefore assessed to those beneficiaries) and what portion is assessed to the trustee.

Where a beneficiary is presently entitled, the trustee issues that beneficiary with a statement showing the amounts to be included in the beneficiary's own tax return — including any franking credits and capital gains streamed to them. The beneficiary then includes those amounts in their personal return at their marginal rates.

Beneficiaries Presently Entitled

A beneficiary is presently entitled to a share of the trust income when, at the end of the income year, the beneficiary has an immediate, vested and indefeasible right to demand payment of that share from the trustee. For ordinary discretionary trusts, this is normally addressed by a year-end trustee resolution. For a deceased estate, the analysis is different because the beneficiaries of the residue do not have an enforceable right to a share of income until the residue itself has been ascertained.

That has two practical consequences:

• in the early stage of administration, the residuary beneficiaries are usually not presently entitled to estate income, and that income is taxed to the trustee; and
• once administration is sufficiently complete that residue is ascertained, the residuary beneficiaries become presently entitled to income arising after that point, and that income is taxed to them at their marginal rates.

A specific gift of income (for example, a will that gives 'all rent from my Smith Street property to my daughter for her life') can create present entitlement from day one for that specific income stream, independently of whether residue has been ascertained.

Trustee Assessment Rules

Where no beneficiary is presently entitled to a share of the estate's net income, the trustee is assessed and pays the tax. Two key provisions apply:

• Section 99: applies where the accumulation is in the ordinary course of administration and no anti-avoidance concern arises. Tax is calculated at individual rates (broadly), and the ATO has long accepted that section 99 generally applies to ordinary deceased estates during the early stages of administration. A limited tax-free threshold is available to a deceased estate for a number of income years from the date of death.
• Section 99A: applies where the Commissioner forms the view that it would not be unreasonable, having regard to the legislative criteria. Tax is calculated at the top marginal rate plus Medicare levy. Section 99A is the default; section 99 applies only because the Commissioner exercises the discretion.

The difference between the two outcomes is material. A poorly-administered estate that simply accumulates income without obtaining advice can find itself paying tax at the top marginal rate on amounts that could easily have been streamed to beneficiaries on lower marginal rates.

Distribution of Estate Income

'Distribution' for trust-tax purposes is not the same as physically paying cash to a beneficiary. A beneficiary can be presently entitled to income that has not yet been paid; conversely, an executor can advance cash to a beneficiary before that beneficiary becomes presently entitled. The two concepts have to be kept apart. The tax treatment follows present entitlement — not the date the cheque is signed.

For executors, the practical question at year-end is usually: has the residue been ascertained? If yes, the residuary beneficiaries are presently entitled to income arising after that point and the streaming analysis is straightforward. If no, the income for that year is generally trustee-assessed, with the section 99 / 99A analysis above.

Undistributed Estate Income

Income that has not been streamed to a presently entitled beneficiary by 30 June is, by default, trustee-assessed. Executors sometimes accumulate income deliberately (because they cannot yet identify who is entitled or because a dispute is on foot) and sometimes by inadvertence (because nobody turned their mind to year-end). The cost of inadvertent accumulation can be very high once section 99A applies. This is the single most common preventable error in deceased estate tax administration.

Interest Income

Bank interest is one of the most common forms of estate income. The rules are straightforward:

• interest credited up to the date of death is reported in the deceased's date-of-death return;
• interest credited after the date of death is estate income;
• once the account is in the executor's name with an estate TFN, the bank reports the interest to the estate, not the deceased; and
• until the account is converted, banks may withhold TFN amounts — the executor should notify the bank quickly to avoid unnecessary withholding.

Dividend Income

For listed shares, the cut-off is the dividend's record date: dividends with a record date on or before the date of death belong to the deceased and are reported in the date-of-death return; dividends with a record date after the date of death are estate income. Franking credits attach to the dividend and follow it — where the dividend is streamed to a presently entitled beneficiary, the franking credit is streamed too (subject to the rules in the franking provisions). Where the trustee is assessed, the franking credit is generally available to the trustee. Streaming the right franking credits to the right beneficiaries is a useful planning tool and is one of the practical reasons to bring an accountant into the administration early.

Rental Income

Rent earned on estate-owned real property after the date of death is estate income. The estate claims the usual rental-property deductions — agent fees, council rates, insurance, repairs and (importantly) interest on any inherited mortgage. Where the will gives a beneficiary a life interest in the property, the beneficiary is generally presently entitled to the rent and is taxed on it. Where the property is part of the residue and is held by the executor pending sale or transfer, the rent is estate income and is dealt with under the present entitlement / trustee assessment analysis above.

Capital Gains Considerations

Death itself is not a CGT event. The key rules are:

• when the executor sells a CGT asset during administration, normal CGT rules apply and the estate's net income includes any capital gain;
• the cost base inherited from the deceased generally rolls over (with special rules for pre-CGT assets and for the deceased's main residence);
• where a CGT asset is transferred in specie from the executor to a beneficiary, that transfer is generally a CGT roll-over and the beneficiary takes the cost base; and
• the deceased's main residence can be sold without CGT within two years of the date of death if it was the deceased's main residence at the date of death and not used to produce income during the relevant period — the Commissioner has a discretion to extend the two-year period.

Capital gains made by the estate can, like other income, be streamed to a beneficiary who is specifically entitled, with the beneficiary taxed at their marginal rates and with the CGT discount and any small business concessions preserved (subject to the streaming rules).

Estate Versus Beneficiary Taxation

The decision between estate-level and beneficiary-level taxation is rarely the executor's to make freely. It is usually dictated by:

• the stage of administration (residue ascertained or not);
• the terms of the will (specific income gifts versus residuary entitlement);
• whether a beneficiary has any legal disability (a minor or a beneficiary lacking capacity); and
• the timing of the trustee's accounting and resolutions.

Once administration is complete and the residue is ascertained, the natural position is that residuary beneficiaries are presently entitled to income going forward and are taxed on it. Beneficiaries who are unsatisfied with how the executor is handling income should read our note on beneficiary rights during estate administration.

Testamentary Trusts

Where the will establishes a testamentary trust — typically for the benefit of a spouse, children or grandchildren — income paid or applied to the testamentary trust is income of that trust, not of the estate. The testamentary trust then lodges its own trust tax return and the trustee makes its own distribution decisions year by year.

The most important tax feature of a testamentary trust is section 102AG of the Income Tax Assessment Act 1936: distributions from a testamentary trust to a minor can be taxed at adult marginal rates, rather than at the penal minor rates that apply to ordinary family trust distributions to minors. For families with young children or grandchildren, that concession can be very valuable — but it depends on the trust being properly characterised and properly funded with assets that came from the deceased estate. See our companion article on testamentary trusts explained.

Timing Issues During Administration

Tax outcomes can turn on a few days. Common timing issues include:

• the date the residue is ascertained — which determines when residuary beneficiaries become presently entitled;
• year-end accumulation — income earned in late June can fall into trustee assessment if nothing is done before 30 June;
• the record date of a dividend — pushing the deceased's holding into or out of an entitlement;
• the two-year window for the deceased's main residence;
• the date a CGT asset is transferred in specie versus sold;
• the timing of distributions where one beneficiary has marginal-rate advantages over another; and
• the date a testamentary trust is funded.

Common Executor Mistakes

The most common executor mistakes in this area are:

• not obtaining an estate TFN and continuing to use the deceased's accounts;
• treating all income as 'the deceased's' and trying to put everything in the date-of-death return;
• accumulating estate income at year-end without obtaining advice and triggering section 99A;
• distributing cash to beneficiaries before the residue has been ascertained, without thinking about present entitlement;
• missing the two-year main residence window;
• failing to track franking credits on estate dividends;
• failing to stream capital gains to the beneficiary who can absorb them most efficiently;
• funding a testamentary trust late, after substantial income has already been earned in the estate; and
• poor record-keeping, making it impossible to defend the position taken in the estate return.

Record Keeping Requirements

The executor should keep records of:

• every income receipt — interest statements, dividend statements, distribution statements and rent records;
• every deduction — invoices, contracts, agent statements and bank fee summaries;
• the date of every transfer of an asset and the consideration for it;
• every valuation obtained, with the basis for it;
• every distribution to a beneficiary and the date of present entitlement;
• every CGT cost-base item, including the deceased's original purchase records, capital improvements and asset transfers; and
• every piece of correspondence with the ATO.

CGT records should be kept for the life of the asset plus five years. General tax records should be kept for five years from the date of the relevant return.

When Accounting and Legal Advice Should Be Obtained

Specialist accounting and legal advice should be obtained whenever:

• the estate includes a private company or a trust interest (see our note on what happens when a director or shareholder dies in our article on what happens to a company when a director or shareholder dies);
• the estate includes a business — see also our overview at what happens to a business when an owner dies;
• the estate holds significant CGT assets, rental property, foreign assets or cryptocurrency;
• the will creates a testamentary trust;
• a beneficiary is under a legal disability (a minor or a person lacking capacity);
• the administration period is likely to extend beyond a single income year;
• there is a dispute among beneficiaries; or
• the estate is likely to be challenged.

How Parke Lawyers Can Help

We act for executors, beneficiaries, accountants and family members across Australia on the legal aspects of estate administration that intersect with tax — ascertaining the residue, structuring distributions, establishing and funding testamentary trusts, handling company and trust interests in the estate, and resolving disputes about how estate income has been administered. Our services in these areas include probate and estate administration, wills and estate planning, commercial and business law and estate litigation and TFM claims.

This article is general information only. It is not taxation advice and it is not legal advice. Estate taxation is technical and depends on the facts of the individual estate. Executors and beneficiaries should obtain advice from a tax-qualified accountant and a specialist estates lawyer before lodging an estate return, distributing estate income or restructuring estate assets.

Frequently Asked Questions