What Taxes Do You Pay on Trusts?

A trust is a legal arrangement between a settlor and trustees where the latter manage assets belonging to the former for the benefit of specified beneficiaries, so there are three persons involved—the trustee, the settlor, and the beneficiary. A trust is established with the intention of providing financial security and flexibility to those who are important to the settlor. It is a way of ensuring that the value of the assets passes to the intended individuals and is protected from any legal or financial issues that may arise.  

The details of the trust arrangement are outlined in a legal document known as the “trust deed.” This document sets out the names of the people involved, the terms of the trust, and the rights and responsibilities of the settlor, trustees, and beneficiaries. The trust deed is a legally binding document that outlines the terms of the trust and is enforceable by law.  

A trust can also be established through a will. This type of trust is known as a testamentary trust and is established upon the death of the settlor. Testamentary trusts allow for the transfer of assets to beneficiaries in a tax-efficient manner and can provide a level of financial security for the beneficiaries.  

Setting up a trust can provide a flexible and effective way of ensuring that the value of your assets passes to the individuals you choose, in a tax-efficient manner. It is an excellent way of providing financial protection for those who are important to you, ensuring that your assets are managed and protected for future generations.  

This article discusses the different kinds of taxes that trusts entail and how setting up one can be very tax-efficient on your part.  

Trust and Income Tax 

There are different types of trusts, each with its own income tax on investments rates. When trust income is less than £1,000, you will be taxed 7.5 per cent for dividend-type income and 20 per cent for all other income. On the other hand, if the trust income exceeds £1,000, the dividend-type profits will be charged at 38.1 per cent whilst all other income will be at 45 per cent.  

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In some cases, the two types of trusts income, for example, the accumulation or discretionary trusts and settlor-interested discretionary trusts can be received by the beneficiaries as if they have already been taxed at 45 per cent. 

This applies to them even if they are an additional rate taxpayer. This means they basically don’t pay income tax. Since there is 45 per cent credit attached to it, they can apply for a refund of any overpaid tax through their Self-Assessment tax return for the year. 

When trustees set up trust for vulnerable or disabled people, they would also get a more tax-efficient advantage as the recipient would not have to pay the top rate income tax should they receive the income directly as an individual. 

Trust income can be distributed to the family as well, taking advantage of their income tax’s personal allowances and lower bands, all the whilst maintaining the trustees’ control of the trust’s underlying assets. 

Trust and Capital Gains Tax 

Capital Gains Tax is a tax on the increase in value (the “gain”) of an asset when it is transferred into or out of a trust. When assets are taken out from a trust, the trustees usually pay the tax if they sell or transfer the assets for the benefit of the beneficiary. 

In bare trusts, there is no tax owed when assets are transferred to the beneficiary. In certain cases, the transfer of an asset to someone else may be exempt from Capital Gains Tax, such as when an “interest in possession” terminates upon death. 

Tax reliefs help you avoid capital gains tax if you’re eligible. With Private Residence Relief, trustees are exempt from Capital Gains Tax when they sell a property owned by the trust, as long as it is the primary residence for someone who is permitted to reside there according to the trust’s regulations. 

For Business Asset Disposal Relief, Trustees pay a 10 per cent Capital Gains Tax on eligible gains if they sell assets used in a beneficiary’s business that has ceased operation. They may also receive relief when selling shares in a company where the beneficiary held at least 5 per cent of shares and voting rights. 

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Lastly, you can also claim Hold-Over Relief in which trustees are not taxed when they transfer assets to beneficiaries (or to other trustees in some instances). The recipient pays tax on the sale or disposal of the assets, unless they claim relief. 

Trust and Inheritance Tax 

Inheritance Tax (IHT) may be owed on a person’s estate (property and assets) upon their death. The tax rate is 40 per cent for any amount over the threshold, but if the person’s will donates over 10 per cent of their estate to charity, the rate is reduced to 36 per cent. Inheritance Tax may also apply if a portion of a person’s estate is transferred into a trust while they are still alive. 

IHT is levied on “relevant property” such as cash, stocks, real estate, and land. This includes most assets in trusts. There are exceptions where Inheritance Tax may not be owed, such as when the trust holds excluded property, and other special circumstances that mitigate tax for inheritance purposes. 

One example is bare trusts. These trusts have assets held in the name of a trustee but are immediately passed to the beneficiary, who has the right to both the assets and income of the trust. Transfers into a bare trust may also be exempt from Inheritance Tax, if the person making the transfer survives for 7 years after the transfer. 

On the other hand, for disabled beneficiaries’ trust, no 10-year charge or exit charge applies as long as the asset remains in the trust and the interest of the beneficiary. Additionally, the transfer of assets into a trust for a disabled person is exempt from Inheritance Tax as long as the person making the transfer survives for 7 years after the transfer. Beneficiaries can greatly benefit through different ways from the tax-efficiency of setting up trusts. If you need help in settling your trust, Legend Financial is here to help.