Discretionary Trust, Wills & Inheritance Tax

Is the trust subject to tax in the normal way?

Yes. The trustees are subject to income and capital gains tax in the same way as individuals. After a deduction for the trust’s management expenses, the trust income is taxed at 40% (32.5% for dividends). In addition, capital gains are also subject to tax after deducting the trustees’ annual exemption which is, at most, half that of an individual.

The trustees will receive a tax return in exactly the same way as an individual. The filing deadlines and the dates for the payment of tax are exactly the same as for individuals.

Distributions of income to beneficiaries, including the surviving spouse or civil partner, will suffer income tax in the hands of the beneficiary but with a credit for the tax paid by the trustees. To the extent that the tax paid by the trustees exceeds the income tax liability arising to the beneficiary on such income, a tax refund will be made to the beneficiary. Capital can be appointed to beneficiaries tax free in all but exceptional circumstances.

A discretionary trust is subject to inheritance tax every 10 years after the creation of the trust. The rate at which the tax is paid at current rates is not more than 6% of the market value of the trust’s assets at the time of the charge and a nil rate discretionary trust will often escape tax altogether.

There is also a charge when assets cease to be held on discretionary trust, eg if assets pass out of trust to a beneficiary. In this case, the charge to inheritance tax is based on:

  • the value of the property leaving the trust
  • the proportion of the period of 10 years for which the assets have been held on discretionary trust since the last 10 year charge
  • the rate of tax at the last 10 yearly charge

but subject to any inheritance tax reliefs available at the time.

What sort of property should be included in the trust?

In many instances, it will not matter what property is included in the trust. However, where a person holds business or agricultural property, significant tax advantages can be obtained in structuring legacies between the trust and a surviving spouse or civil partner and further tax planning advice should be sought. Further advice should also be sought where all or part of the nil rate band legacy will need to be satisfied by a transfer of the family home, as additional structuring will be required to ensure that the planning remains effective. Drafting of the clauses can be critical to ensure that no unexpected tax charges arise eg stamp duty land tax.

Who should I nominate as trustees?

This is a very personal decision. Essentially, you will probably want to choose trusted family members or close friends. You should check that the people you nominate are willing to act for you. You might also wish to include a professional trustee, though this may be dependent on the complexity of your affairs. Trusts and wills are often written on very flexible terms allowing trustees greater discretion in their management. The increasing complexity of modern trust and tax law as well as the reluctance of many people to become involved in decisions that require not only a professional competence but also an independent detachment from family dynamics means that an independent trust company may be the best choice – especially as the trust company is always there and doesn’t die, retire or take holidays.

What other matters should I consider?

This factsheet is a summary of the legal position in England and Wales. Different legislation may apply in Scotland, Northern Ireland and other jurisdictions.

It is important that you understand the implications of making a will that includes a nil rate band discretionary trust. You need to understand what the particular inheritance tax implications are of you owning a particular piece of property. You should ensure that all areas are considered so that your trustees will administer the trust in accordance with your wishes and instructions.

It is important to review your will every few years to take account of changing circumstances and relationships. Apart from these regular reviews, it is essential to reconsider your intended bequests after separation or divorce. Furthermore, remarriage generally revokes an existing will in its entirety, which may leave children of the former marriage without any claim on your estate.

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