Income Tax implications: The two main types of trusts

18th June 2023

Discretionary Trust

A discretionary trust is a trust which gives you maximum control over the income and capital held. It is the trustee’s decision whether the beneficiaries receive any distributions and therefore income and capital is only released at the discretion of the trustees – the beneficiaries are not entitled to receive anything.

Due to the above, these trusts are taxed fairly harshly. Income is taxed at the highest rates of tax – currently 45% for savings and non-savings, 38.1% on dividend income. This means yearly tax returns would be required to report the income and pay the tax owed. Income distributions made from the trust on a Form R185 are deemed to be paid net of 45% tax which the beneficiaries could claim back if their tax rate is less than this.

The Self-assessment tax return for trusts is due by 31 January following the end of the tax year with the payment deadline also being the same date. Payments on account could also apply if the tax payable by the trust exceeds £1,000 per year.

Interest in Possession Trusts

Unlike the discretionary trust, the beneficiaries have a right to receive the income of the trust. This can be mandated to them which would avoid the trust having to complete yearly tax returns. The trustees have no discretion over the income payments (as the beneficiaries are absolutely entitled) but still maintain control over the capital.

Each beneficiaries would then need to report the income received on their tax return and pay the tax accordingly.

If no mandate was put in place, the trust would pay tax at basic rates (20% on savings and non-saving income, and 7.5% on dividend income). The beneficiaries would then be supplied with an R185 reporting the income and tax paid on their share which they would then need to report on their own return. If their tax rate was higher than basic rate, they would be liable to pay the increase.

This trust therefore has the flexibility to have minimal administration while the beneficiaries receive the income and the capital is protected and managed by the trustees. The trustees must pay the income to the beneficiaries but the reporting of this income is then the responsibility of the beneficiaries.

Our team can guide you through all aspects of trusts so that you can create a plan for protecting your assets for generations to come. So get in touch today to discuss our probate services and let us help make the process smooth, straightforward, and worry-free.

Other articles in this series:

What do I need to consider to set up a trust?

What are the two main types of trusts?

Inheritance tax implications for a relevant property trust

What to do when a trust is wound up

Related Contacts

Sam Bilcliff

Sam Bilcliff Probate & Personal Tax Manager

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Paul Carnell

Paul Carnell Partner

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