Trusts and Income Tax

Different types of trust income have different rates of Income Tax.

Each type of trust is taxed differently. Trusts involve a ‘trustee’, ‘settlor’ and ‘beneficiary’.

Accumulation or discretionary trusts

Trustees are responsible for paying tax on income received by accumulation or discretionary trusts. The first £1,000 is taxed at the standard rate.

If the settlor has more than one trust, this £1,000 is divided by the number of trusts they have. However, if the settlor has set up 5 or more trusts, the standard rate band for each trust is £200.

The tax rates are below.

Trust income up to £1,000

Trust income over £1,000

Dividends

Trustees do not qualify for the dividend allowance. This means trustees pay tax on all dividends depending on the tax band they fall within.

Interest in possession trusts

The trustees are responsible for paying Income Tax at the rates below.

Sometimes the trustees ‘mandate’ income to the beneficiary. This means it goes to them directly instead of being passed through the trustees.

If this happens, the beneficiary needs to include this on their Self Assessment tax return and pay tax on it.

Bare trusts

If you’re the beneficiary of a bare trust you’re responsible for paying tax on income from it.

You need to tell HMRC about the income on a Self Assessment tax return.

If you do not usually send a tax return, you need to register for self-assessment by 5 October following the tax year you had the income.

Settlor-interested trusts

The settlor is responsible for Income Tax on these trusts, even if some of the income is not paid out to them. However, the Income Tax is paid by the trustees as they receive the income.

1. The trustees pay Income Tax on the trust income by filling out a Trust and Estate Tax Return.
2. They give the settlor a statement of all the income and the rates of tax charged on it.
3. The settlor tells HMRC about the tax the trustees have paid on their behalf on a Self Assessment tax return.

The rate of Income Tax depends on what type of trust the settlor-interested trust is.

Other types of trust

There are special tax rules for parental trusts for children, trusts for vulnerable people and trusts where the trustees are not resident in the UK for tax purposes. These are called non-resident trusts.

Trusts and Capital Gains Tax

Capital Gains Tax is a tax on the profit (‘gain’) when something (an ‘asset’) that’s increased in value is taken out of or put into a trust.

When Capital Gains Tax might be payable

If assets are put into a trust

Tax is paid by either the person:

• selling the asset to the trust
• transferring the asset (the ‘settlor’)

If assets are taken out of a trust

The trustees usually have to pay the tax if they sell or transfer assets on behalf of the beneficiary.

There’s no tax to pay in bare trusts if the assets are transferred to the beneficiary.

Sometimes an asset might be transferred to someone else but Capital Gains Tax is not payable. This happens when someone dies and an ‘interest in possession’ ends.

A beneficiary gets some or all of the assets in a trust

Sometimes the beneficiary of a trust becomes ‘absolutely entitled’ and can tell the trustees what to do with the assets, for example when they reach a certain age.

In this case, the trustees pay Capital Gains Tax based on the assets’ market value when the beneficiary became entitled to them.

Non-UK resident trusts

The rules for Capital Gains Tax on non-UK resident trusts are complicated. You can get help with your tax.

Working out total gains

Trustees need to work out the total taxable gain to know if they have to pay Capital Gains Tax.

Allowable costs

Trustees can deduct costs to reduce gains, including:

• the cost of the property (including any administration fees)
• professional fees, for example for a solicitor or stockbroker
• the cost of improving property or land to increase its value, for example building a conservatory (but not repairs or regular maintenance)

Tax reliefs

Trustees might be able to reduce or delay the amount of tax the trust pays if gains are eligible for tax relief.

Tax-free allowance

Trustees only have to pay Capital Gains Tax if the total taxable gain is above the trust’s tax-free allowance (called the Annual Exempt Amount).

The tax-free allowance for trusts is:

• £6,150
• £12,300 if the beneficiary is vulnerable – a disabled person or a child whose parent has died

If there’s more than one beneficiary, the higher allowance may apply even if only one of them is vulnerable.

See tax-free allowances for previous years.

The tax-free allowance may be reduced if the trust’s settlor has set up more than one trust (‘settlement’) since 6 June 1978.

There’s more detailed information about Capital Gains Tax and Self Assessment for trusts.

Report gains to HMRC

Trustees must report and pay any tax due on UK residential property using a Capital Gains Tax on UK property account. They must do this within:

• 60 days of selling the property if the completion date was on or after 27 October 2021
• 30 days of selling the property if the completion date was between 6 April 2020 and 26 October 2021

Trustees must report the sale or transfer of other assets in a trust and estate Self Assessment tax return.

Download and fill in a Trust and Estate Tax Capital Gains form (SA905) if you’re a trustee sending a tax return by post.

The rules are different for reporting a loss.

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 – 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.

Special rules

Some types of trust are treated differently for Inheritance Tax purposes.

Bare trusts

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 cannot 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

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 do not 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 do not 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.

Paying Inheritance Tax

You pay Inheritance Tax using form IHT100.

If you’re valuing the estate of someone who’s died, you may have to value other assets apart from trusts to see if Inheritance Tax is due.

Beneficiaries – paying and reclaiming tax on trusts

If you’re a trust beneficiary there are different rules depending on the type of trust. You might have to pay tax through Self Assessment or you might be entitled to a tax refund.

If you do not usually send a tax return and need to, you must register for Self Assessment by 5 October following the tax year you had the income.

Read the information on the different types of trust to understand the main differences between them. If you’re not sure what type of trust you have, ask the trustees.

If you’re the beneficiary of a bare trust you are responsible for declaring and paying tax on its income. Do this on a Self Assessment tax return.

If you do not usually send a tax return and need to, you must register for Self Assessment by 5 October following the tax year you had the income.

Interest in possession trusts

If you’re the beneficiary of this type of trust, you’re entitled to its income (after expenses) as it arises.

If you ask for a statement, the trustees must tell you:

• the different sources of income
• how much income you’ve been given
• how much tax has been paid on the income

You’ll usually get income sent through the trustees, but they might pass it to you directly without paying tax first. If this happens you need to include it on your Self Assessment tax return.

If you do not usually send a tax return you must register for Self Assessment by 5 October the year after you were given the income.

Example

You were given income from the trust in August 2021. You need to register for Self Assessment before 5 October 2022.

If you’re a basic rate taxpayer

You will not owe any extra tax. You’ll still need to complete a Self Assessment tax return to show the income you receive from an interest in possession trust but you will get a credit for the tax paid by the trustees. This means the income is not taxed twice.

If you’re a higher rate taxpayer

You’ll have to pay extra tax on the difference between what tax the trustees have paid and what you, as a higher rate taxpayer, are liable for. This will be calculated when you do your Self Assessment.

How to reclaim tax

You can reclaim tax paid on:

• dividends (if you’re entitled to dividend allowance)
• savings interest (if you’re entitled to personal savings allowance)
• trade and property income (if you’re entitled to trading allowance or property allowance)

The allowance amount will be reduced if it’s already been used against some income. The allowance you have left is called the ‘available allowance’.

If the amount of income you receive is less than or equal to the available allowance, you can reclaim all of the tax paid.

If the amount of income you receive is more than the available allowance, you can only claim the tax paid on the available allowance.

Example

You received £10,000 of dividend income from a trust in the 2021 to 2022 tax year. The dividend allowance for that year was £2,000.

You have used your personal allowance but you have no other dividend income so your available dividend allowance is £2,000. The trustees have paid tax of £750 on the dividends (£10,000 x 7.5%).

You can reclaim the tax paid by the trustees on an amount equal to your available dividend allowance so you can reclaim £150 (£2000 x 7.5%).

If you’re a Self Assessment taxpayer the repayment will be calculated as part of your return.

If you’re not a Self Assessment taxpayer you can reclaim the tax using form R40.

You need to make a separate claim for each tax year.

Accumulation or discretionary trusts

With these trusts all income received by beneficiaries is treated as though it has already been taxed at 45%. If you’re an additional rate taxpayer there will be no more tax to pay.

You may be able to claim tax back on trust income you’ve received if any of the following apply:

• you’re a non-taxpayer
• you pay tax at the basic rate of 20%
• you pay tax at the higher rate of 40%

You can reclaim the tax paid using form R40. If you complete a tax return, you can claim through Self Assessment.

Settlor-interested discretionary trusts

If a settlor-interested trust is a discretionary trust, payments made to the settlor’s spouse or civil partner are treated as though they’ve already been taxed at 45%. There’s no more tax to pay. However, unlike payments made from other types of trusts, the tax credit cannot be claimed back.

Non-resident trusts

This is a trust where the trustees are not resident in the UK for tax purposes. The tax rules for this type of trust are very complicated – there’s detailed guidance on non-resident trusts.

If a pension scheme pays into a trust

When a pension scheme pays a taxable lump sum into a trust after the pension holder dies, the payment is taxed at 45%.

If you’re a beneficiary and receive a payment funded by this lump sum, you’ll also be taxed.

You can claim back tax paid on the original lump sum – do this on your Self Assessment tax return if you complete one, or using form R40.

The trust will tell you the amount you need to report – this will normally be more than the amount you actually receive.