Taxation of trusts and estates
What the exam tests
Taxation tests the interaction of inheritance tax (IHT), capital gains tax (CGT) and income tax across lifetime trusts, death estates and administrations. Questions usually require a calculation and an explanation of who bears the tax.
IHT
Lifetime transfers are PETs or CLTs. A PET is potentially exempt and becomes chargeable only if the transferor dies within seven years; a CLT is immediately chargeable at 20% on the excess over the available nil rate band (NRB). Death transfers are charged at 40%, with the NRB (£325,000) and residence nil rate band (£175,000, tapered over £2m) applied in the correct order. Cumulative lifetime transfers in the seven years before death use the NRB first. Trusts pay periodic (10-year) and exit charges on relevant property.
CGT and income tax
Death is not a disposal for CGT; assets are rebased to market value. Lifetime gifts by trustees may be held over. Trusts have a reduced annual exempt amount. Discretionary and accumulation trusts pay income tax at the trust rate (45%, with 39.35% on dividends), subject to the standard rate band; interest in possession trusts tax the beneficiary. Personal representatives pay basic-rate income tax during administration.
Worked example
A settlor transfers £500,000 to a discretionary trust, with £325,000 NRB unused. The CLT is £500,000; tax at 20% on £175,000 is £35,000, payable by the trustees. If the settlor pays the tax, the transfer must be grossed up. If the settlor survives seven years, the £35,000 is refunded and the transfer falls out of the cumulation.
Traps
Do not deduct the annual exemption twice; do not apply the RNRB to lifetime trusts; do not charge CGT on death; and check whether the trust deed or statute makes the beneficiary or trustees liable for income tax.