Trusts and Inheritance Tax
Inheritance Tax may be due on assets when they are transferred into or out of trust and on certain trusts at each 10-year anniversary.
Inheritance Tax and settled property
The act of putting an asset - such as money, land or buildings - into a trust is often known as ‘making a settlement’ or ‘settling property’.
For Inheritance Tax purposes, each asset has its own separate identity. This means, for example, that one asset within a trust may be for the trustees to use at their discretion and therefore treated like a discretionary trust. Another item within the same trust may be set aside for a disabled person and treated like a trust for a disabled person. In this case, there will be different Inheritance Tax rules for each asset.
Even though different assets may receive different tax treatment, it is always the total value of all the assets in a trust that is used to work out whether a trust exceeds the Inheritance Tax threshold and whether Inheritance Tax is due. There are different rules for different types of trust.
Inheritance Tax and excluded property
Some assets are classed as ‘excluded property’ and Inheritance Tax is not paid on them. However, the value of the assets may be brought in to calculate the rate of tax on certain exit charges and 10-year anniversary charges. Types of excluded property can include:
- property situated outside the UK - that is owned by trustees and settled by someone who was permanently living outside the UK at the time of making the settlement
- government securities - known as FOTRA (free of tax to residents abroad)
The rules governing excluded property can be complicated.
Assets in a trust such as money, shares, houses or land are known as ‘relevant property’. Most property held in trusts counts as relevant property. Inheritance Tax may be due on the assets held within a trust when:
- they are transferred out of a trust (exit charges)
- a 10-year anniversary occurs
The only exceptions to this rule are when the asset is:
- in an interest in possession trust and it was put there before 22 March 2006
- subject to a ‘transitional serial interest’ made between 22 March 2006 and 5 October 2008
- put into an interest in possession trust by the terms of a will or the rules of intestacy
- set aside for a disabled person
- set aside for a bereaved minor
- put into an age ‘18 to 25 trust’
Transfers into trust
A transfer of assets into a trust can include buildings, land or money and can be either of the following:
- a gift made during a person’s life
- a transfer or transaction that reduces the value of the settlor’s estate (for example an asset is sold to trustees at less than its market value) - the loss to the person’s estate is considered a gift or transfer
Work out if Inheritance Tax is due
For most types of trust Inheritance Tax is due when you make transfers that total more than the Inheritance Tax threshold of £325,000. You work this out by adding up the value of any transfers (based on the loss in value to the settlor’s estate) and any chargeable gifts made in the previous 7 years by the settlor. Inheritance Tax is due on everything above the threshold.
If the trustees pay, the rate of tax is 20%. If the settlor pays the Inheritance Tax instead of the trustee, this means there will be an increased loss from the settlor’s estate. The amount of tax due will therefore increase. These calculations are complex.
Death within 7 years of making a transfer
If you die within 7 years of making a transfer into a trust your estate will have to pay Inheritance Tax at the full amount of 40%. This is instead of the reduced amount of 20% which is payable when the payment is made during your lifetime.
In this case your personal representative - who manages your estate when you die - will have to pay a further 20% out of your estate based on the value of the original transfer.
If no Inheritance Tax was due when you made the transfer, the value of the transfer is added to your estate when working out whether any Inheritance Tax is due.
If you make a gift into any type of trust but continue to benefit from the gift - for example, you give away your house but continue to live in it - you will pay 20% on the transfer and the gift will still count as part of your estate. These are known as gifts ‘with reservation of benefit’. Find out more about passing on property.
This creates a situation where there are 2 possible Inheritance Tax charges if you die:
- a charge when you transfer the gift into a trust
- a charge to your estate when you die - because the asset is still considered part of your estate
To avoid double taxation, only the higher of these charges is applied - in other words you won’t ever pay more than 40% Inheritance Tax.
Gifts into a trust for someone who is disabled
You don’t have to pay Inheritance Tax immediately if you make a gift to a trust for someone who is disabled but Inheritance Tax may still be due when you die.
Find out more about how Inheritance Tax applies to trusts for someone who is disabled.
The Inheritance Tax exit charge
Inheritance Tax is charged up to a maximum of 6% on assets - such as money, land or buildings - transferred out of a trust. This is known as an ‘exit charge’ and it’s charged on all transfers of relevant property.
Transfers out of trust
A transfer out of trust can occur when:
- the trust comes to an end
- some of the assets within the trust are distributed to beneficiaries
- a beneficiary becomes ‘absolutely entitled’ to enjoy an asset
- an asset becomes part of a ‘special trust’ (for example a charitable trust or trust for a disabled person) and it ceases to be ‘relevant property’
- the trustees enter into a non-commercial transaction that reduces the value of the trust fund
When there isn’t an Inheritance Tax exit charge
There are some occasions when there is no Inheritance Tax exit charge - these apply even where the trust is a ‘relevant property’ trust. For instance, it isn’t charged:
- on payments by trustees of costs or expenses incurred on assets held as relevant property
- on some payments of capital to the beneficiary where Income Tax will be due
- when the asset is transferred out of the trust within 3 months of setting up a trust, or within 3 months following a 10-year anniversary
- when assets are ‘excluded property’ - some foreign property is excluded property
Calculating the Inheritance Tax exit charge
The calculations for the Inheritance Tax exit charge are complicated. You’ll need the following information before you can begin:
- the value - before any reliefs - of all the assets transferred into the trust in question, valued at the dates of transfer
- the value of all other transfers into other trusts made by the settlor on the same day as the trust in question was set up, valued at the date they were added
- the value of all transfers chargeable to Inheritance Tax that the settlor made in the seven years before the trust in question was set up, valued at the date they were made
Once you have this information there will be a different calculation depending on whether the:
- transfer out of the trust occurs during the first 10 years of a trust’s life
- transfer out occurs after the first 10 years
- trust is an ‘18 to 25 trust’
The 10-year anniversary charge
As a trustee, you’ll have to pay a charge on every tenth anniversary of the date your trust was set up if your trust contains relevant property with a value above the Inheritance Tax threshold.
Work out the Inheritance Tax
Inheritance Tax is charged at each 10-year anniversary of the trust. It’s charged on the net value of any relevant property in the trust on the day before that anniversary. Net value is the value after deducting any debts and reliefs such as Business or Agricultural Relief. There are different rules if the trust was set up before 27 March 1974.
The calculation for the 10-yearly charge is complicated. Before you can begin, you’ll need the following information:
- the value of the relevant property in the trust on the day before the 10-year anniversary
- the value - at the date it entered the trust - of any trust property that has not been relevant property at any time while in this trust
- the value of any property in any other trust (except wholly charitable trusts) that the settlor set up on the same date as this trust - use the value from the date it was set up
- the value of any transfers subject to Inheritance Tax (whether into trusts or not) that the settlor made in the 7 years before this trust was set up - use the value at the date of transfer
- the value of any transfers - at the date they were transferred - of relevant property out of the trust within the last 10 years
- whether any of the relevant property was relevant property in the trust for less than the last 10 years
Dealing with a trust when someone dies
When someone dies, the job of managing their estate may involve dealing with trusts.
The deceased may have wanted their assets put into trust when they die, or part of their estate may have already been held in trust.
The executor or administrator of the deceased’s estate - known as the ‘personal representative’ - must find out the total value of the estate.
Inheritance Tax is due on everything above the Inheritance Tax threshold (£325,000 for the tax year 2016 to 2017). This can become more complicated when a trust is involved.
There are 3 main ways that the deceased’s personal representative may have to deal with a trust when working out whether Inheritance Tax is due.
1. When the deceased was the beneficiary of a trust
Some trusts are set up so that the beneficiary has ownership or a legal right to the income or assets in the trust. This will affect what’s included in the estate of the beneficiary when they die.
A bare trust is one where the beneficiary is entitled to both the income and the assets in the trust. Therefore, when they die, both income and assets are considered part of their estate. The personal representative needs to work out whether there is any Inheritance Tax to pay and include the deceased’s interest in the bare trust, on form IHT400 Inheritance Tax Account.
An interest in possession trust is one where the beneficiary is entitled to only the income from a trust. When they die, there are certain circumstances where the value of this ‘interest in possession’ is calculated as part of their estate. These include when the trust:
- was set up before 22 March 2006
- was set up after 22 March 2006 and was either an ‘immediate post death interest’, a ‘disabled person’s interest’ or a ‘transitional serial interest’ trust
If you’re the personal representative you’ll need to work out the value of an ‘interest in possession’ and complete questions 45 and 75 on form IHT400. You’ll need to liaise with the trustees to get this information. It is the trustees’ duty to complete an IHT100 Inheritance Tax Account form. This form must also be completed when an interest in possession trust comes to an end.
2. When the deceased transferred assets into a trust before they died
There may have been an Inheritance Tax charge of 20% when assets were transferred into a trust. If you’re the personal representative you must find out whether the deceased made any transfers into a trust in the 7 years before they died. If they did, and they paid Inheritance Tax at that time, the tax will be recalculated at 40% and a credit allowed for the tax paid when the trust was set up. The trustees will be liable to pay the extra tax. You must show this on form IHT400 at question 28.
Even if no Inheritance Tax is due on the transfer you may need to add its value to the deceased’s estate when you’re working out the value for Inheritance Tax purposes.
3.When a trust is set up by a will
Someone might ask in their will that, when they die, some or all of their assets are placed in a trust. A trust set up under these circumstances is known as a ‘will trust’. The personal representative must then make sure that the trust is set up properly and all taxes are paid on assets going into it.
Once it’s set up, it is the trustees’ duty to make sure Inheritance Tax is paid on any further transfers into or out of the trust. They do this by completing the IHT100 Inheritance Tax Account form.
Telling HM Revenue and Customs about charges
If Inheritance Tax is due on assets in a trust you’ll need to fill in form IHT100 and the relevant event form - IHT100a to IHT100g.
Some trusts don’t have to send in an IHT100 form as long as they meet the rules for excepted transfers and settlements - usually trusts with a low value.
Doing the exit charge calculation yourself
If you want to do the calculations yourself you need to enter your figures into Sections G and H on form IHT100.
You can download a worksheet and guidance notes to help you work out how much Inheritance Tax you’ll need to pay.
If you’re calculating the 10-year anniversary charge and some of the assets in a trust haven’t been relevant property for all of the 10 years, the tax may be reduced by the number of quarters that the asset wasn’t relevant property. You can use the Inheritance Tax quarters calculator to help you work this out.
You can also use this example of how to calculate the 10-yearly charge to help you.
Getting HMRC to do the calculation for you
If you want HMRC to work out the charges for you, fill in form IHT100 leaving sections G and H blank. You’ll still need to complete the relevant event form. You need to return the form to HMRC in good time for the calculation to be worked out - otherwise you may be charged a penalty or interest on the Inheritance Tax due.
Deadlines, penalties and payments
If the chargeable event occurred on or after 6 April 2014, trustees must pay Inheritance Tax by the end of the sixth month after the event. The trustee must also report the event to HMRC, using form IHT 100, by the end of the sixth month after it happened.
If the chargeable event occurred before 6 April 2014, trustees must pay Inheritance Tax by the end of the sixth month after the event. The trustee must report the event to HMRC, using form IHT 100, within a year of the event happening.
HMRC will charge interest on payments received after the due date.