The Benefits of Trusts in Estate Planning

OSK can advise on trust tax issues, including filing of trust returns with the Revenue.  

Note that OSK, does NOT advise on trust set up nor on the trust deed itself.

Estate planning is best described as planning for the transfer of assets to the next generation(s) in the most tax efficient way, while talking account of the legal obligations to dependents.  It is worth considering the use of trusts - for both life time gifts and for an inheritance passing under a will. 

What is a Trust?

A trust is a legal device created to deal with the management of property on behalf of another person. 

The settler is the person who places the asset in trust.  The trustee is the person who holds the legal title to the asset but not the beneficial interest.  The beneficiaries are the people that the settler wants to benefit from the assets. The trustees hold the title for the benefit of the named beneficiaries. The trustees cannot benefit or obtain any personal advantage from their position as trustee.

Once a trust is established the settlor generally loses all rights to the property unless he/she retains a power of revocation.

There are various types of trust and I briefly define below a discretionary trust and when it may be useful.

A discretionary trust arises where trust property is held by trustees on trust to apply the income or capital for the benefit of specified beneficiaries in such proportion as the trustees in their absolute discretion think fit.  The beneficiaries have no interest in the fund for legal or taxation purposes and they cannot call for distributions in their favour – they can only ask to be considered. The settlor can provide the trustees with a letter of wishes (which has no binding effect) indicating how he/she wishes the trust fund to be managed.

A discretionary trust may be considered useful for the following purposes:

(i)       To ring-fence and protect certain assets

(ii)       To hold asset for young children (assets either passing on death or during lifetime)

(iii)      To preserve assets for future generations – rather than passing all assets to the next generation only

(iv)      To provide for a child with a disability

(v)       To provide for children who cannot manage their own affairs (for reasons other than a disability)

(vi)      To provide for a non-marital partner

Tax on Transfer to the Trust

 Capital Gains Tax and Stamp Duty

The disposal to the trust will be a disposal for capital gains tax purposes and any gain arising will be subject to capital gains tax (subject to reliefs and losses and the connected party rules will apply).  An asset that has dropped in value could also be transferred to generate a loss to offset against any capital gain on other assets.

Stamp Duty may also fall due on the transfer.

Capital Acquisitions Tax

The creation of a discretionary trust or any additions to the trust fund will not give rise to a charge to CAT.

If the trustees of a discretionary trust make an appointment in favour of a beneficiary who becomes beneficially entitled in possession a charge to CAT will arise.

Trustees Tax Liability

 Income Tax and Trusts

Trustees are assessed to Income Tax in respect of the trust income in the following manner:

• They are subject to Income Tax on the trust income at the standard rate currently 20% (the Income Tax paid is available as a credit against a beneficiaries tax liability).
• In addition they may be subject to the Income Tax surcharge at a rate of 20% where the income of the trust is not distributed within 18 months of the end of the tax year in which it arose (the surcharge is not allowed as a credit against beneficiaries tax liability).
• They are not entitled to claim personal tax credits and personal rate bands.
• They do not pay PRSI or USC on trust income.

Capital Gains Tax

The trustees will pay capital gains tax on any disposals they make, either within the trust or on a transfer out of the trust to a beneficiary.  The trustee’s base cost will be the market value on the date the assets were settled on trust.

Tax on Distributions to Beneficiaries

Distributions to beneficiaries will either be capital (and subject to capital acquisitions tax) or income (and subject to income tax).  The fact that a benefit is paid out of the capital of a trust does not mean that it will not be taxed as income in the hands of the beneficiary.  Where payments are made out of current year trust income those payments are likely to be treated as income, but payments out of accumulated income may be regarded as capital appointments depending on the circumstances.  If a payment is expended on routine living expenses it will be treated as income and will be assessable to income tax, social security and universal social charge.

Discretionary Trust Tax

 Initial Levy (once-off charge)

An initial levy of 6% falls due on the later of the following dates:-

(1)  The date the property became subject to the discretionary trust

(2)  The date of death of disponer or

(3)  The date on which there ceases to be a ‘principal object’ of the trust who is under 21 years of age, (principal object includes spouse or child of disponer but not grandchildren (unless a child of a deceased child). The 6% levy is charged on the value of the trust assets held by discretionary trust on the latest of the above three dates.

Once the initial levy fall due the trust becomes a “chargeable discretionary trust” and becomes subject to annual levy 1% (but the annual levy is not payable in same year as initial levy).

Example

‘A’ is aged 55 and has three children aged 19, 22 and 26.  ‘A’ has three investment properties – total value €600,000 and he has cash of €300,000. He wishes to preserve this wealth for his children and grandchildren, however, he believes property prices will continue to rise and for this reason it would be preferable to dispose of the assets now while their values are relatively. However, he does not wish to make an outright gift to his children as he has the following concerns:

(i)       The 19 year old is too young and A has a concern that he may sell the house and mis-use the proceeds

(ii)       The 22 year old  is very sensible but A does not wish to give her an unfair advantage over her siblings by gifting the house and cash to her now

(iii)       The 26 year is married with two children but the marriage is not going well and A is concerned that if the marriage breaks up that the house and any gift of cash would form part of a break-up settlement.

 ‘A’ decides to transfer the assets to a discretionary trust, for the following reasons.

• There is no capital acquisitions tax to pay on the transfer to the trust so the NIL rate band and the group threshold are preserved
• The assets are protected from being misused or misspent
• The assets are ring-fenced and protected for the intended beneficiaries and will survive the next generation
• The assets no longer form part of A’s estate
• The trustees could make income payments to the beneficiaries to use the beneficiaries personal allowances and credits
• There are no discretionary trust taxes to pay until the later of ‘A’’s death or his youngest son reaching 21
• Any beneficiary may be allowed to live in one of the houses and the house may be transferred free of capital acquisitions tax subject to the beneficiary meeting the conditions for dwelling house relief
• Distributions can be made to the beneficiaries at the discretion of the trustees and in line with A’s wishes

The disposal by ‘A’ will be a disposal for capital gains tax purposes.  ‘A’ had previously invested €250,000 in shares which are now only worth €50,000 so he will transfer these shares to the trust to generate a capital loss of €200,000 to offset against the gain.

Imelda Prendergast is Director OSK Small Business Support and OSK Contracting. Contact Imelda Prendergast today for more information on estate planning and trusts on 01 439 4200.

OSK can advise on trust tax issues, including filing of trust returns with the Revenue.  

Note that OSK, does NOT advise on trust set up nor on the trust deed itself.

Disclaimer

This article is a very brief guide to discretionary trusts and the taxes arising thereon and professional advice should be sought before any action is taken.  The information contained in this article not to be taken as professional advice and is given on the express understanding that neither this company nor any of its employees or directors are to be held responsible for any errors or omissions.