Do trusts pay inheritance tax? This is a question that often arises when individuals consider establishing a trust to manage their assets. Understanding the tax implications of trusts is crucial for both the settlor and the beneficiaries, as it can significantly impact the distribution of wealth upon the settlor’s death. In this article, we will explore the intricacies of inheritance tax and its application to trusts.
Trusts are legal arrangements where one person, known as the settlor, transfers assets to another person or entity, known as the trustee, for the benefit of a third party, the beneficiary. Trusts can be created for various purposes, such as protecting assets from creditors, ensuring the financial security of loved ones, or avoiding probate. However, one of the primary concerns for many settlors is the potential tax implications, particularly when it comes to inheritance tax.
Inheritance tax is a tax paid on the estate of someone who has passed away. It is calculated based on the value of the estate, which includes all assets owned by the deceased at the time of death, as well as certain gifts made in the seven years before their death. The rate of inheritance tax is 40%, but this is only applied to the amount of the estate that exceeds the £325,000 threshold (or £650,000 for married couples and civil partners).
When it comes to trusts, the answer to whether they pay inheritance tax is not straightforward. The tax treatment of trusts depends on several factors, including the type of trust, the nature of the assets held within the trust, and the relationship between the settlor and the beneficiaries.
Types of Trusts and Inheritance Tax
There are two main types of trusts that can be subject to inheritance tax: lifetime trusts and testamentary trusts.
1. Lifetime Trusts: These are trusts created during the settlor’s lifetime. Inheritance tax may be due on lifetime trusts if the settlor has retained any beneficial interest in the trust assets. This is known as a “settlor’s interest” and can include the right to income or capital from the trust. If the settlor retains a beneficial interest, the value of the trust assets may be included in their estate for inheritance tax purposes.
2. Testamentary Trusts: These are trusts created in a will and come into effect upon the settlor’s death. Testamentary trusts are generally not subject to inheritance tax in the year of death, as they are considered part of the deceased’s estate. However, if the trust continues to exist for more than seven years after the settlor’s death, any assets transferred to the trust may be subject to inheritance tax at the 6% annual rate on the value of the assets.
Exemptions and Relief
In some cases, trusts may be exempt from inheritance tax or entitled to certain reliefs. For example:
1. Spousal and Civil Partner Trusts: Trusts set up for the benefit of a spouse or civil partner are generally exempt from inheritance tax.
2. Charitable Trusts: Trusts established for charitable purposes are exempt from inheritance tax.
3. Business Relief: Trusts that hold business assets may be eligible for business relief, which can reduce the value of the assets for inheritance tax purposes.
Conclusion
In conclusion, whether trusts pay inheritance tax depends on various factors, including the type of trust, the settlor’s interest, and the relationship between the settlor and the beneficiaries. It is essential for individuals considering a trust to consult with a tax professional to understand the potential tax implications and ensure that their estate planning goals are achieved while minimizing tax liabilities. By understanding the complexities of inheritance tax and trusts, individuals can make informed decisions about how best to manage their assets for the benefit of their loved ones.
