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Money, tax and benefits
Tax on income and gains from UK family trusts
UK trust tax is paid by the trustees (legal owners of the trust property) out of trust funds. A trust beneficiary may also have to pay tax separately on the income they receive from a trust. If you set up a trust for your children or set up a trust from which you can benefit yourself, you may have extra tax to pay.
Tax on bare trusts
In this type of trust the beneficiaries pay tax on the trust's income and capital gains at their normal tax rates. The trust itself isn't taxed at all.
Tax on interest in possession trusts
Trustees of an interest in possession trust complete a trust tax return and pay tax on the trust income at the following flat rates:
| Type of income | Trust tax rates for 2008-09 |
|---|---|
| Rent and trading income | 20% |
| Savings income, eg bank interest | 20% |
| Dividends and distributions | 10% |
Tax on beneficiaries' income
The beneficiaries are entitled to the income of the trust, after expenses, and pay tax at their normal rates (after personal allowances) on it.
But because this income has already been taxed once, if they're starting rate (10 per cent) taxpayers or non-taxpayers they'll be able to reclaim some or all of the tax already paid by the trust on it (apart from the 10 per cent deducted at source on dividends, which can't be repaid).
Tax on discretionary trusts
Trustees of a discretionary trust complete a trust tax return each year and pay tax on the trust income at the following flat rates:
Trust income up to £1,000
| Type of income | Tax rate 2008-09 |
|---|---|
| Rent and trading income | 20% |
| Savings income, eg bank interest | 20% |
| Dividends and distributions | 10% |
Trust income over £1,000
| Type of income | Tax rate 2008-09 |
|---|---|
| Dividends and distributions | 32.5% |
| Other income | 40% |
In some circumstances the trustees may have extra tax to pay when they pay income to the beneficiaries. This is explained below.
Tax on the beneficiaries
All discretionary trust income paid to beneficiaries is treated as if tax has already been paid at 40 per cent.
For example, if the beneficiary is paid £600 out of trust income the beneficiary's total income (before tax) from the trust is considered to be £1,000, with £400 (40 per cent) having already been paid in tax.
As a result, a beneficiary who is a non-taxpayer, 10 per cent or 20 per cent taxpayer may be able to reclaim all or some of the tax back.
A higher rate taxpayer can't reclaim. They simply enter the income and 40 per cent tax already paid (the 'tax credit') on their tax return.
Extra trust tax based on payments to beneficiaries
When paying income to beneficiaries, the trustees must make sure they've paid enough tax to cover the 40 per cent being declared (or in some cases reclaimed in part or full) by the beneficiary.
Keeping track via the 'tax pool'
To keep track, trustees keep a record of payments called the 'tax pool'.
This is:
- the tax the trustees have paid at the special trust rates, but excluding the non-refundable 10 per cent on dividends
- the tax paid at the 20 per cent rate as a result of the £1,000 standard rate band
- less any 40 per cent tax credits on payments to beneficiaries
If the amount in the tax pool isn't enough to cover the beneficiary's 40 per cent 'tax credit' in a given year, the trust must pay extra tax to make up the difference. The effect is that the trust pays tax at 40 per cent on all income it pays to the beneficiaries.
But extra tax won't always be payable just because dividend income is paid out - unused amounts in the tax pool can be carried over from year to year.
Trust tax is a complicated area and best dealt with by a trust specialist.
Beneficiary is not the settlor – periods from 6 April 2006
The beneficiary is treated as though they'd paid tax at the higher rate on the actual amount of the payment. The payment is not 'grossed' up and is included in the calculation of that person’s total income.
The tax credit ensures the beneficiary has no further liability in respect of the payment, but it is ring-fenced so that no part of it can be repaid or set against any liability arising from any other income of the beneficiary.
Beneficiary is also the settlor – periods from 6 April 2006
Discretionary payments made by the trustees to the settlor are not taxed on the settlor.
Tax on accumulation and maintenance trusts
In accumulation and maintenance trusts the tax rules are the same as for discretionary trusts - until the beneficiaries become entitled to the income and capital. What happens next depends on what happens to the trust property:
If another trust is being set up
In this case the normal rules for discretionary and interest in possession trusts apply.
If the trust is being wound up
In this case the trustees pay Capital Gains Tax (CGT) on any gain in the value of the assets being passed to the beneficiary above the trust CGT allowance (currently £4,800). After that, the beneficiaries pay tax on any income or gains in the usual way.
Tax on mixed trusts
In a mixed trust, the trustees and beneficiaries are taxed on the income for each part of the trust under the rules for that type of trust.
Tax where the settlor can benefit from a trust
If a person sets up a trust under which:
- minor children of the settlor (the person who sets up the trust) can benefit, or
- the settlor's spouse or civil partner can benefit
Different rules apply and there may be extra tax to pay.
Capital Gains Tax on trusts
Trustees pay CGT when they sell trust assets or pass them to beneficiaries.
Tax on trusts for vulnerable people
From 6 April 2004 special rules apply to the tax on trusts set up for vulnerable people like bereaved children and disabled people.
Trusts and Self Assessment
If you become a trustee and the trust is likely to have income or gains you'll receive a trust tax return each year, usually in April. You'll need to return it, along with any trust tax due, by the following 31 January.
Getting advice on trusts
Trusts are very complicated. Before setting one up get professional advice from a solicitor. It's also advisable to speak to a tax adviser or accountant before agreeing to be a trustee.
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Paying Inheritance Tax
