Trusts and Taxation
A trust is a way of managing assets (money, investments, land or buildings) for people. There are different types of trusts and they are taxed differently.
A simple way to think of a trust is to imagine a trust as a tin box that you can place your assets into. With the assets in the box you can then determine what you want to do, or for what purpose your assets can be put.
A trust gives you control over your money and can protect family assets. It can be a most effective way of managing your affairs.
You can create a trust where someone is too young to manage their financial affairs, or are incapacitated or are vulnerable.
A trust can be created to enable you to pass on assets whilst you are still alive. Often a trust (called a will trust) is created on your death, to pass on property in accordance with your will.
A trust can be used to protect the family, a family protection trust.
There are tax consequences and charges can arise from a trust which we will explain for you.
- the ‘settlor’ – the person who puts assets into a trust
- the ‘trustee’ – the person who manages the trust
- the ‘beneficiary’ – the person who benefits from the trust
What trusts are for
Trusts are set up for a number of reasons, including:
- to control and protect family assets
- when someone’s too young to handle their affairs
- when someone can’t handle their affairs because they’re incapacitated
- to pass on assets while you’re still alive
- to pass on assets when you die (a ‘will trust’)
- under the rules of inheritance if someone dies without a will (in England and Wales)
Types of trust
The main types of trust are:
- bare trusts
- interest in possession trusts
- discretionary trusts
- accumulation trusts
- mixed trusts
- settlor-interested trusts
- non-resident trusts
Parental trusts for children
These are trusts set up by parents for children under 18 who have never been married or in a civil partnership. They’re not a type of trust in their own right but will be either:
- a bare trust
- an interest in possession trust
- an accumulation trust
- a discretionary trust
Income Tax on income from the trust is paid by the trustees, but the ‘settlor’ is responsible for it. This means:
- The trustees pay Income Tax on the trust income by filling out a Trust and Estate Tax Return.
- They give the settlor a statement of all the income and the rates of tax charged on it.
- The settlor tells HM Revenue and Customs (HMRC) about the tax the trustees have paid on their behalf when filling out their Self Assessment tax return.
Trusts for vulnerable people
Some trusts for disabled people or children get special tax treatment. These are called ‘trusts for vulnerable beneficiaries’.
Who qualifies as a vulnerable beneficiary
A vulnerable beneficiary is either:
- someone who has a mental or physical disability
- someone under 18 whose parent has died
Trusts that qualify for special tax treatment
A trust doesn’t qualify for special Income Tax treatment if the person setting it up can benefit from the trust income. However, from 2008 to 2009 it would qualify for special Capital Gains Tax treatment.
Trusts for children who’ve lost a parent are usually set up by the parent’s will, or by special rules of inheritance if there’s no will.
These are the situations when trusts for vulnerable people get special Inheritance Tax treatment:
- for a disabled person – at least half of the payments from the trust must go to the disabled person during their lifetime
- someone suffering from a condition that’s expected to make them disabled sets up a trust for themselves
- for a bereaved minor – they must take all the assets and income at (or before becoming) 18
There’s no Inheritance Tax charge:
- if the person who set up the trust survives 7 years from the date they set it up
- on transfers made out of a trust to a vulnerable beneficiary
When the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate and Inheritance Tax may be charged. Trusts usually have 10-year Inheritance Tax charges, but trusts with vulnerable beneficiaries are exempt.
Click here for information about Parental Trusts For Children.
Trusts and Inheritance Tax
Inheritance Tax may have to be paid on a person’s estate (their money and possessions) when they die. Inheritance Tax is due at 40% on anything above the threshold of £325,000 – but there’s a reduced rate of 36% if the person’s will leaves more than 10% of their estate to charity. Inheritance Tax can also apply when you’re alive if you transfer some of your estate into a trust.
When Inheritance Tax is due
The main situations when Inheritance Tax is due are:
- when assets are transferred into a trust
- when a trust reaches a 10-year anniversary of when it was set up (there are 10-yearly Inheritance Tax charges)
- when assets are transferred out of a trust (known as ‘exit charges’) or the trust ends
- when someone dies and a trust is involved when sorting out their estate
What you pay Inheritance Tax on
You pay Inheritance Tax on ‘relevant property’ - assets like money, shares, houses or land. This includes the assets in most trusts. There are some occasions where you may not have to pay Inheritance Tax – for example where the trust contains excluded property.
Some types of trust are treated differently for Inheritance Tax purposes.
These are where the assets in a trust are held in the name of a trustee but go directly to the beneficiary, who has a right to both the assets and income of the trust.
Transfers into a bare trust may also be exempt from Inheritance Tax, as long as the person making the transfer survives for 7 years after making the transfer.
Interest in possession trusts
These are trusts where the beneficiary is entitled to trust income as it’s produced – this is called their ‘interest in possession’.
On assets transferred into this type of trust before 22 March 2006, there’s no Inheritance Tax to pay. On assets transferred on or after 22 March 2006, the 10-yearly Inheritance Tax charge may be due. During the life of the trust there’s no Inheritance Tax to pay as long as the asset stays in the trust and remains the ‘interest’ of the beneficiary.
Between 22 March 2006 and 5 October 2008:
- beneficiaries of an interest in possession trust could pass on their interest in possession to other
- beneficiaries, like their children
this was called making a ‘transitional serial interest’ – there’s no Inheritance Tax to pay in this situation
From 5 October 2008:
- beneficiaries of an interest in possession trust can’t pass their interest on as a transitional serial interest if an interest is transferred after this date there may be a charge of 20% and a 10-yearly Inheritance Tax charge will be payable unless it’s a disabled trust
If you inherit an interest in possession trust from someone who has died, there’s no Inheritance Tax at the 10-year anniversary. Instead, 40% tax will be due when you die.
If the trust is set up by a will
Someone might ask that some or all of their assets are put into a trust. This is called a ‘will trust’.
The personal representative of the deceased person has to make sure that the trust is properly set up with all taxes paid, and the trustees make sure that Inheritance Tax is paid on any future charges.
If the deceased transferred assets into a trust before they died, or if you’re valuing the estate of someone who has died, you’ll need to find out whether they made any transfers in the 7 years before they died. If they did, and they paid 20% Inheritance Tax, you’ll need to pay an extra 20% from the estate.
Even if no Inheritance Tax was due on the transfer, you still have to add its value to the person’s estate when you’re valuing it for Inheritance Tax purposes.
Trusts for bereaved minors
A bereaved minor is a person under 18 who has lost at least one parent or step-parent. Where a trust is set up for a bereaved minor, there are no Inheritance Tax charges if:
the assets in the trust are set aside just for bereaved minor
they become fully entitled to the assets by the age of 18
A trust for a bereaved young person can also be set up as an 18 to 25 trust – the 10-yearly charges don’t apply. However, the main differences are:
- the beneficiary must become fully entitled to the assets in the trust by the age of 25
- when the beneficiary is aged between 18 and 25, Inheritance Tax exit charges may apply
Trusts for disabled beneficiaries
There’s no 10-yearly charge or exit charge on this type of trust as long as the asset stays in the trust and remains the ‘interest’ of the beneficiary.
You also don’t have to pay Inheritance Tax on the transfer of assets into a trust for a disabled person as long as the person making the transfer survives for 7 years after making the transfer.