Making Trust Distributions
At Finch Tax, we provide support to trustees to ensure that their trust is being administered in accordance with the terms of the trust instrument and adheres to all the latest tax, accounting and reporting rules surrounding trusts.
As we are fast approaching the end of the current tax year, we are currently reviewing the finances of our trust clients so that we can advise the Trustees on what income is available to be paid out to trust beneficiaries. Where trusts allow trustees to make distributions to beneficiaries at their discretion, income distributions to non-taxpayers such as minors, income tax that the trust has already paid (quite often at the rate of 45%!) can be reclaimed by the beneficiaries and this can make the Trust very tax efficient.
Therefore, we thought we would share with you some basics principles on making trust distributions…..
Tips for making trust distributions
It is important that trustees consider making distributions on a regular basis. They have a general duty under law to make sure that the trust assets are distributed to the correct beneficiary and in the correct amounts. Therefore, it is important for trustees to understand the terms in the Trust instrument (usually a trust deed or a Will).
Often the trust instrument gives the following common scenarios:
A beneficiary is given the right to income for their lifetime (or a fixed period) after which the capital passes to other beneficiaries or on a continuing trust;
The trustees have full discretion to distribute the capital and income of the trust as they think fit, and in the meantime, they may distribute or accumulate the income.
When considering making a payment to beneficiaries, trustees should ask themselves the following:
Is it a capital or income payment?
How much discretion do we have over the amount to be paid?
What are the tax consequences of making a payment?
Is it important therefore to know and have a financial record of the split of income and capital in the trust. If trust accounts are prepared properly, keeping a split of capital and income, it should be clear where the payment is coming from.
Making capital payments
If making capital payments, it is important to put correct paperwork in place to support this such as a Trustees Resolution or Deed.
It is also important to ascertain whether the trust capital of the trust forms part of the beneficiary’s estate for inheritance tax purposes or whether the trust capital is subject to the relevant property regime. If the latter, then a charge to inheritance tax at the maximum rate of 6% may arise and this charge will need reporting to HM Revenue and Customs within six months of the distribution.
If you do not know how your trust is taxed, please seek specialist tax advice from us or your current adviser.
Making income payments
Where a beneficiary has the right to income for their lifetime or a fixed period, the income belongs to them and they are ultimately taxed on the income. The Trustees must distribute the income to the beneficiary if they are in receipt of it, but they can agree with the beneficiary how and when to do this. Formal documentation is not required to support income distributions from this type of trust.
Where the trust instrument allows the trustees to distribute income at their discretion (a ‘discretionary trust’) the trustees should consider whether to distribute income, decide how much to distribute and to whom.
They may wish to share income equally between all potential beneficiaries or perhaps those in the same generation. Or they may take into account the needs and personal wealth of the beneficiary. Whatever the decision it is sensible to have a policy in place and review the position periodically.
When making payments out of a discretionary trust, it is important to know what income is available for distribution and what tax pool is available to support the distribution. It is possible to have income available for distribution but if it is all paid out a further income tax charge could arise if there is insufficient tax pool to support the payments.
At the end of the tax year, trustees should give beneficiaries who have received income in the tax year a form R185 (statement of income from trust) and this should be declared as part of their own personal taxes.
Any income being paid out of a discretionary trust is deemed to have suffered tax at 45% and if the beneficiary is not a 45% taxpayer an income tax refund will arise. Therefore, the trustees should consider what tax-free allowances the beneficiaries have available to make the trust as tax efficient as possible.
In view of the above the following are necessary for trustees to make distributions:
An understanding of the terms of the trust instrument and the interests of beneficiaries
A financial record of the split of income and capital in the trust (usually in the form of accounts)
An understanding of the income tax, capital gains tax and inheritance tax regimes applicable to your trust
If you would like assistance with your trust including any matters raised in this article, please do get in touch on 0116 216 7681 or email Rhoda Cooper at firstname.lastname@example.org.