You want to have control over your assets even after you pass away. Trusts offer a great vehicle for this, providing you with control over how your assets are used or divided. When it comes to trust management, below are the top ten tax tips for trusts you should be aware of – and if you are looking for advice on setting up a trust, don’t forget to read our previous post.
1. Inheritance Tax can be reduced but not always avoided
Trusts can often be an effective tool to use to reduce Inheritance Tax. However, there are complex rules behind the tax treatment of trusts and you shouldn’t set up a trust thinking it will completely reduce all tax.
2. Assets in trusts are not part of your estate
When you set up a trust, you can choose which assets to include into your trust. The important thing to note is that any assets you include into the trust will not be included in your estate when you die. Therefore, they are not part of the Inheritance Tax levied on your estate. However, if you die within seven years of placing the assets in the trust, the assets will levy Inheritance Tax.
3. Best tax tips for trusts vary according to the trust type
When it comes to setting up a trust, there are many options available to you. Some of the most common trusts are:
- Discretionary gift trusts – The most popular type of trust and allows you to stipulate how you want the assets to be used by the beneficiaries.
- Bare trusts – Simple trusts that hold assets on another person’s behalf until they take ownership.
- Loan trusts – Can limit future gains in the value of your estate, as you are lending your assets to the trust.
The important thing is to understand how the different trusts work so that you can choose the best type of trust for your needs.
4. Discretionary trusts favoured for reducing Inheritance Tax
As mentioned, discretionary trusts are the most popular type of trust and often favoured for reducing Inheritance Tax. The tax rules on these type of trusts mean you pay reduced Inheritance Tax on assets at the start, during the lifecycle of the trust and at the end of it.
Here is how much Inheritance Tax is paid at various stages:
- You pay 20% Inheritance Tax as you set up a trust. The tax is paid only on the amount not covered by your personal allowance.
- You pay 6% Inheritance Tax every 10 years. Each decade, the value of those assets will be re-valued and a 6% charge is levied on the value of the total assets.
- You pay 6% inheritance tax when the trust is closed or the assets are removed. This tax is based on the most recent 10-year evaluation.
5. Take advantage of the personal allowance
For the most effective tax planning, consideration of your personal allowance is crucial. Inheritance Tax comes with a tax-free allowance of £325,000, which is known as the nil-rate band, and it works like any other tax allowance. For example, in the case of the discretionary trust, the 20% inheritance tax you need to pay on assets when setting up will only be paid on the amount that’s over the £325,000 threshold.
6. Bare trusts are exempt of Inheritance Tax
Bare trusts can be exempt of Inheritance Tax altogether. There will be no tax on the assets if the person making the asset transfers lives for 7 years after the initial transfer.
7. Trusts are subject to Capital Gains Tax
Tax tips for trusts also consider other taxes aside from Inheritance Tax. You might need to pay Capital Gains Tax (CGT) when putting assets into a trust or when you take them out of the trust. In bare trusts, CGT is not levied if the assets are transferred to the beneficiary.
The total taxable gain also has to be above the trust’s tax-free allowance. For trusts this is:
- £6,000
- £12,000 if the beneficiary is deemed vulnerable
8. Certain trusts need to consider Income Tax
For discretionary and accumulation trusts, income tax is something to consider. Trustees are responsible for paying tax on income they receive from those trusts, with the first £1,000 taxed at the standard rate.
Income tax rates for trust income are as follows:
- Trust income up to £1,000 – dividends taxed at 7.5%, with all other income at a rate of 20%.
- Trust income over £1,000 – dividends taxed at 38.1% and all other types of income at 45%.
9. Trustees are responsible for filing and paying taxes
Trustees are responsible for reporting and paying tax on behalf of the trust. Trustees need to register with HMRC, with the registration deadline for new trusts being 5 October and for existing trusts 31 January. Trustees are also obliged to tell beneficiaries about the trust’s tax and income.
10. Consider other costs aside from tax on trusts
You should keep in mind that taxes are not the only cost to consider when setting up a trust. In addition to the different taxes payable, trustees usually charge a fee to manage trusts and other legal costs might be associated with the trust. Therefore, the cost of setting up a trust, as the taxes payable, will depend on your circumstances.
Seek advice on trusts and taxation
Trusts are an effective tool for managing your inheritance and assets. However, as the above tax tips for trusts show, the different tax rules around trusts can be complicated and depend on individual circumstances. Therefore, it is important to consult a tax specialist to ensure your trust works for you and your beneficiaries.
If you are thinking about launching a trust or you would like help with your existing trust, we can help you with the process. We at Devonshire Green have experience in managing trusts so our team can answer any queries you might have. Contact us today and let’s take control of your finances!
