Trusts and estates

Trusts

In its simplest form, a trust is an arrangement where an asset, like a property, is transferred by a person (the settlor) to one or more people (the trustees) to hold for other people (the beneficiaries). The trustees agree to look after the trust assets and, depending on the terms of the trust agreement, will use the assets of the trust for the benefit of the beneficiaries.

You might see trusts like this called ‘express trusts’. This means any kind of trust that has been deliberately created by the settlor. Often – but not always – there will be a trust ‘deed’ or document setting out the terms of the trust, so it usually will be quite clear that a trust exists. If you are in any doubt, then you should seek advice (see below).

It is now necessary for most express trusts to be registered under HMRC’s trust registration service. You can read more about this on our page Trust registration service.

Trust deed

Usually, a trust deed is used to create a trust.

A trust deed is the legal document that sets out:

• when the trust is established
• what assets will go into the trust
• who the trustees are
• who the beneficiaries are
• how the beneficiaries can benefit from the trust

How the beneficiaries can benefit from the trust can impact how the trust is taxed.

There does not always have to be a trust deed for a trust to exist. This is particularly true in the case of bare trusts (discussed below), which can be created very informally in some cases, perhaps with just a verbal agreement between parties.

Types of trust

There are three main types of trust, as explained below. However, there are many variations of the different types of trust and how they can be set up. This information is just a brief overview.

Bare trust

This is the most basic type of trust. In this case the beneficiary is entitled to the income and capital of the trust, in the same way as if the asset is owned directly by them outright. In other words, the trustee is just looking after the trust assets on the beneficiary’s behalf. This might be because they are under the age of 18 and cannot legally own certain assets at that age. This is sometimes called a ‘nominee’ arrangement.

Discretionary trust

Where a trust is ‘discretionary’, the settlor will set out a list of potential beneficiaries in the trust deed and will give the trustees power to choose who benefits from the trust income/capital, and when.

Usually, the trustees do not have to pay anything out of the trust each year. For example, they might leave any income within the trust until they decide it is appropriate to pay some to the beneficiaries. This means that the beneficiaries of a discretionary trust have a mere ‘hope’ of receiving funds from the trust rather than an actual right to funds.

Sometimes, the settlor of a discretionary trust will also prepare a ‘letter of wishes’ to go alongside the trust deed. A letter of wishes aims to provide a little more information as to how the settlor would like the trustees to use their discretionary powers. The trustees are not required to follow it.

Interest in possession trust

This is also sometimes called a ‘fixed interest trust’ or ‘life interest trust’. In Scotland, this sort of trust is called a ‘liferent trust’.

In this sort of trust, one or more beneficiaries are entitled to the trust’s income each year. Or perhaps the beneficiary might use the trust assets, for example living in a property owned by the trust. However, the beneficiary is unable to access the capital (trust assets).

The beneficiary receiving the income or using trust property is often called the ‘life tenant’.

Will trust

A will trust is any kind of trust created on a person’s death under their will. This is not a separate type of trust – it could be a bare trust, a discretionary trust, or an interest in possession trust. In the case of a will trust, the deceased person is the settlor.

Often in the case of a will trust, there will not be a separate trust deed – the deceased person’s will sets out the terms of the trust and therefore the trust deed is part of the will itself.

How trusts are taxed

With a bare trust, the beneficiary is treated for tax as if they owned the property themselves. This means they are liable for any tax arising as if they held the property directly. If the bare trust is settled by the parent of a minor child then the parent might be taxable on the income if it is more than £100 (before any tax is taken off) in a tax year.

For most other kinds of trusts, it is the trust itself that is taxable on any income or capital gains that arise. In practice, this means that the trustees are responsible for reporting and paying the trust’s tax liabilities to HMRC. The trustees pay the tax from the funds held in the trust.

However, if the settlor can benefit from the trust, normally any income and gains will be taxed on the settlor.

The inheritance tax position varies depending on the type of trust and how and when it was established. The inheritance tax rules can be complicated.

Below is a basic summary of the tax implications for each sort of trust. Note that for income tax purposes, a trust cannot be a Scottish taxpayer or a Welsh taxpayer, so the rates referred to below are main UK tax rates:

Income tax

Bare trust

Charged to income tax as income of the beneficiary, unless settled by the parent of a minor child and the income is more than £100 a year.

Discretionary trust

The trust has no personal allowance. The taxation of discretionary trusts has changed from 6 April 2024.

For tax years up until 2023/24, the first £1,000 of income is taxed at the basic rate. Any income above this is chargeable to tax at the additional rate.

For tax years from 2024/25 onwards, there is a change in how discretionary trust income is taxed, as follows:

• If the trust’s total income is less than £500, no tax is payable by the trustees and there is usually no reporting requirement – an exception to this is if a discretionary income distribution is made to a beneficiary, sometimes this will give rise to a tax pool charge, described below under the heading: Income distributions.
• If the trust’s total income is £500 or more, then the entire amount is taxable at the additional rate and a trust tax return must be submitted.

Broadly speaking, if there are several discretionary trusts established by the same settlor, then the £500 tax and reporting limit is divided between the trusts, subject to a minimum £100 limit per trust. There are certain exceptions to this, so it is recommended that you take advice. See under the heading below: Getting help.

Income distributions

If trust income is distributed to beneficiaries, the income is always treated as carrying a 45% tax credit in the hands of the beneficiary. To calculate the 45% tax credit, the trustees must perform the following calculation:

• £ amount of the distribution x 45/55

This information is given to the beneficiary on a form R185 (trust income).

If the trust was a non-taxable trust, then matters can become complicated – this is because the trust needs to have paid enough tax previously to cover the tax credit. If the trust has not paid enough tax (or has not paid any tax), the trustees will need to submit a tax return for the tax year of the distribution and pay the necessary tax to ‘fund’ the tax credit. This is called a tax pool charge.

Example: Non-taxable discretionary trust makes an income distribution

The Peach Discretionary Trust is established in May 2024. The trust receives bank interest of £400 for the period up to 5 April 2025. On 5 April 2025, the trustees decide to make an income distribution of £100 to one of the beneficiaries.

The tax credit attaching to the distribution is £100 x 45/55 = £81.82.

Therefore, the trustees provide the following information to the beneficiary on the form R185 (Trust income):

• Net payment:    £100
• Tax credit:          £81.82

Note: the beneficiary is treated as receiving gross trust income of £181.82, with £81.82 tax deducted at source. If the beneficiary pays tax at a lower rate, they will be able to reclaim the difference from HMRC.

When the trustees come to consider the trust’s tax position after the end of the tax year, they will need to consider two things:

1. Did the trust receive income of £500 or more? – In this case the answer is no, the trust received £400 of interest in 2024/25.
2. Does the trust need to pay a tax pool charge? – In this case the answer is yes. The trust has only existed since May 2024, and has never paid any tax, so it has no existing tax pool. The trustees have made an income distribution to a beneficiary which is deemed to have been made net of 45% tax, which is £81.82. The trustees will need to pay this as a tax pool charge.
3.  
4. Consequently, the trustees will need to complete a trust tax return and pay the liability to HMRC by 31 January 2026. 

  Trustees of discretionary trusts will need to be careful when making income distributions if they have income below £500 and have little or no carried forward tax pool. In the example above, if the trustees had decided to make an income distribution of the full £400, and had gone ahead with the payment before preparing the form R185 (Trust income), they might not have realised the payment would need to be net of 45% tax and would potentially have distributed more ‘income’ than was actually available.

Interest in possession trust

For tax years up until 2023/24, interest in possession trusts are taxable on all of their income at the basic rate of tax.

From 2024/25, there is a change in how interest in possession trusts are taxed, as follows:

• If the trust’s total income is less than £500, no tax is payable and there is no reporting requirement.
• If the trust’s total income is £500 or more, than the entire amount is taxable at the basic rate and a trust tax return must be submitted.

Unlike with discretionary trusts, interest in possession trusts will usually always have a £500 tax reporting limit, even if the settlor has established more than one trust. It is recommended that you take advice in any case where there are multiple trusts established by the same settlor to ensure you are clear whether or not the £500 limit applies, as the rules can be complicated. See under the heading below: Getting help.

Income distributions

Income distributions from an interest in possession are automatic – the ‘life tenant(s)’ are entitled to all of the income arising.

The distributions made to the life tenant(s) - in other words, the beneficiary(ies) - only carry a ‘tax credit’ if tax was actually payable by the trustees. Interest in possession trusts do not have the same tax pool charge issue as described for discretionary trusts, above.

The trustees give a form R185 to the life tenant showing how much tax (if any) has been deducted from the income which the beneficiary has received in the tax year. The beneficiary can then reclaim tax if they pay tax at a lower rate, or may have to pay further tax via self assessment if they pay tax at a higher rate.

Capital gains tax

Bare trust

Charged to capital gains tax as though the asset was owned directly by the beneficiary.

Discretionary trust

The trust usually has half a CGT annual exempt amount. CGT is then charged at the top rate (20% or 24% depending on the asset, based on 2024/25 rates).

Interest in possession trust

The trust has half a CGT annual exempt amount. CGT is then charged at the top rate (20% or 24% depending on the asset, based on 2024/25 rates). Business asset disposal relief may be available in limited circumstances.

Inheritance tax

Bare trust

Charged to inheritance tax as part of the estate of the beneficiary. 

Discretionary trust

Assets entering the trust in excess of the settlor’s IHT nil rate band are charged to IHT at 20% (or at an effective rate of 25% if the settlor pays the IHT).

The trust must then calculate a further charge to IHT every ten-year anniversary of the trust’s creation, and whenever capital is paid out of the trust to a beneficiary. You can read more about these charges on GOV.UK.

The trust assets do not form part of the beneficiary(ies) estate(s) for IHT, unless the trustees pay capital out to the beneficiary – in which case the assets no longer belong to the trust.

Interest in possession trust

In many cases the IHT position for an interest in possession trust will be the same as for a discretionary trust – so a 30% charge on assets entering the trust during the settlor’s lifetime and then ten-year anniversary charges.

However, where an interest in possession trust is established on death (for example under a will) then the assets of the trust will usually form part of the estate of the beneficiary (the life tenant) – even though they are only receiving the income and are not able to access the capital. No ten-year anniversary charges will arise where the assets are treated as forming part of the beneficiary’s estate.

Different rules apply to interest in possession trusts established prior to March 2006. You can read about these further in HMRC’s Inheritance Tax Manual on GOV.UK.

There are special tax rules that can apply to trusts for certain vulnerable people, including certain people with disabilities. You can read more about these trusts on our page Trusts for disabled people.

Getting help

Trusts can be a complex area of law and tax. We recommend you get competent professional advice when setting up or administering a trust. See our Getting help section for how to find professional advice relating to trusts.

Estates

When someone dies, their personal representatives must carry out the administration of the estate. This includes dealing with the tax position of the deceased for the year of death and their own position as personal representatives until they have completed the administration of the estate.

The personal representatives must gather in the estate assets, pay liabilities and distribute the estate. The period during which they carry this out is the administration period.

How an estate is taxed

The personal representatives will have to use funds from the estate to pay any tax liabilities that arose in the tax year of death, from the start of the tax year to the date of death.

In addition, as the administration period may last months or even years, the personal representatives may have to pay various taxes in their capacity as personal representatives of the estate, from the date of death to the date when the administration period ends.

Similar to trusts, new rules apply for low value estates (those with income of less than £500 in a tax year) from 2024/25. We explain more about how estates are taxed on our page Tax on income and gains after death.