News
Understanding the taxation of Trusts
29 Sep 2025
Contact Us
Contact Us
Contact Us
Trusts are centuries-old legal arrangements that remain an important aspect of modern financial planning. At their simplest, trusts allow one person to transfer assets into the care of trustees who manage them for chosen beneficiaries.
These trust arrangements can be made during someone’s lifetime or written into a will and take effect after their death. They are regularly used to safeguard family wealth, ensuring children and grandchildren benefit from assets which have been passed down, in a controlled way, across generations.
Trusts remain valuable tools for protecting assets and future planning, even as recent changes have reduced some of their tax advantages.
The three parties that make up a trust
There are three main parties needed in order for a trust to work, and each role helps to form a flexible arrangement for families.
Settlor
This is the person who sets up the trust and transfers assets such as cash, property, or investments into it.
Trustee
They are appointed to look after the trust property and must follow the instructions in the trust deed, ensuring they act within the best interest of the beneficiaries as well as UK tax reporting rules. Trustees can be family members, professionals, or a combination of the two.
Beneficiaries
These people are for whom the trust is designed to benefit. They may receive income, capital, or both upon receipt of the trust, depending on what type it is.
Types of trusts and why they matter for tax
The tax implications of a trust depend heavily on the type that is chosen. Typically, there are three main trusts as well as one or two more specialist ones.
Bare Trusts
This is the simplest trust of the three. In it, the beneficiary has absolute entitlement to the assets within it, even if they can’t access them until they’re 18, and for tax purposes, the income and gains are treated as belonging to them too.
Discretionary Trusts
Trustees here have the power to decide which beneficiaries receive what and when. Discretionary trusts are often used by families who want to offer long-term support while keeping some control. Tax here is paid at a higher trust rate, but beneficiaries can reclaim tax if their own liability is lower
Interest in Possession Trusts
Here, a named person called a “Life Tenant” is entitled to the income for life and the underlying capital is preserved for future beneficiaries.
Niche Trusts
Some more specific trusts include Immediate Post-Death Interest trusts and offshore trusts. Both come with specific rules, with each one having different effects on control and taxation.
What you need to know about Income Tax and trusts
Income tax affects the three aforementioned trusts in very different ways.
For a Bare Trust, income is taxed on the beneficiary as though they own the assets directly. Anti-avoidance rules apply if parents place assets in a bare trust for their child whose income exceeds £100 to stop families diverting income for tax.
All income above £500 in Discretionary Trusts is taxed at the highest trust rates, which are 45% on most income and 39.5% on dividends. “Low-income trust” rules may exempt the trust from filing a tax return if the income is under £500. Distributed income comes with a 45% tax credit, and basic-rate taxpayers could reclaim the excess, which turns trust distribution into tax-efficient income.
In Interest in Possession Trusts, income is usually taxed at the 20% basic rate or 8.75% for dividends, and beneficiaries must declare it and may owe extra if they are higher-rate taxpayers. Trustees can mandate income directly to the beneficiary to bypass trust tax altogether.
The facts around Capital Gains Tax (CGT) and trusts
Trusts must pay CGT when they sell or transfer assets at a profit at rates of 20% for most assets and 28% for residential property, respectively.
Gains can trigger tax more quickly because trusts generally only have half of an individual’s annual CGT exemption.
However, some trustees can claim “holdover relief” and defer CGT until the recipient sells the asset in the future.
Gains in Bare Trusts are taxed as if they belong to the beneficiary, giving them access to the full personal allowance.
How Inheritance Tax (IHT) affects trusts
Trusts and IHT are very closely linked, and both can reduce or create liabilities.
On creation of the trust, if assets are transferred above the nil-rate band of £325,000, a 20% lifetime charge could apply immediately, though couples can combine allowances to raise this to £650,000.
Most trusts then face a review every 10 years to see if the trust’s assets exceed the nil-rate band. A tax of up to 6% may apply, although business and agricultural reliefs can reduce this significantly.
A proportionate IHT charge may be owed when assets are paid out of a trust. These are called exit charges.
IHT rules are much simpler in a Bare Trust because the assets belong to the beneficiary outright, so this tax only applies when they die.
Overall, trusts can be very effective for families with businesses or farms, as Business Property Relief can eliminate IHT on certain qualifying assets.
Why offshore trusts are a complex area
Trusts which are located offshore come with a host of complexities, all of which make seeking professional advice very important.
Offshore trusts tend to be used by internationally mobile families, and while income from overseas assets may escape UK tax, UK income is still taxable.
This means that the tax advantages of an overseas trust are lost if the settlor or a close relative benefits from it because income and gains will likely be attributed back to them.
Excluded property trusts can be a powerful tool for non-UK domiciliaries because foreign assets inside the trust can remain outside the UK IHT net indefinitely if it was set up before the individual is deemed to be UK-domiciled.
Trusts are complex, but still matter for family wealth
Trusts remain an essential tool for families who want control and protection for their assets, even in spite of complex tax rules.
They allow wealth to be passed on gradually and shield hard-earned assets from risks when set up correctly. Trusts can preserve family wealth for several generations and reduce exposure to IHT and other taxes.
Get in touch to discuss your trust today
Understanding said taxes requires analysis of the structure and people involved for it to be done right, and at WR Partners, our specialists advise all the major parties on how to set up and manage these trusts efficiently.
Why not avoid the costly consequences of trust mismanagement and get in touch with our team instead?
