John and Mary have established a family trust where Mary is the settlor and the trust holds investments generating income. Their two adult children are beneficiaries of the trust. John, as trustee, distributes all income earned by the trust to the children annually. Which of the following is the primary tax benefit of this income-splitting strategy given Mary is the settlor?

Question: John and Mary have established a family trust where Mary is the settlor and the trust holds investments generating income. Their two adult children are beneficiaries of the trust. John, as trustee, distributes all income earned by the trust to the children annually. Which of the following is the primary tax benefit of this income-splitting strategy given Mary is the settlor?

Answer options:

• It eliminates income tax on the distributed income. ✅ It shifts the tax burden from Mary to the children, who are in lower tax brackets.
• It allows for capital gains to be taxed at a lower corporate rate.
• It defers the payment of tax until the trust is eventually wound up.

Correct answer: It shifts the tax burden from Mary to the children, who are in lower tax brackets.

Explanation: Despite Mary being the settlor, the trust deed can be structured to allow for distributions to be taxed in the hands of the beneficiaries (the children). This shifts the income from a potentially higher-income settlor to lower-income beneficiaries, thereby reducing the overall family tax burden.