As experienced Tax Advisors to Accountants we are often requested to support our clients with regard to Trusts queries.
In most cases the drafting of a Will is straightforward, with the assets left to a spouse or divided amongst the children, however, sometimes the disposer will want to make provisions for someone who is vulnerable or perhaps has a medical condition. This would generally involve the setting up of a trust.
Trustees would be appointed to administer the Trust.
There are three types of trust.
- Bare Trust
- Fixed Interest Trust
- Discretionary Trust
Bare trust – this occurs where a trustee holds legal title to assets on behalf of the beneficiary, who has an immediate and absolute right to the asset. These are typically used when providing for a minor, who would lack legal capacity. When the minor reaches majority (a certain age) the assets are transferred.
Fixed interest trust – under a fixed interest trust the trustee has no discretion in the distribution of the assets. Beneficiaries of the trust have a predetermined, fixed interest in a specific portion of the income or capital of the trust.
A beneficiary may be granted present entitlement to the income of the trust for a specific period of time, for example their lifetime. On the expiration of that limited interest the trust assets vest automatically and absolutely in a specified beneficiary known as the remainderman. The valuation of such interests is complex.
John leaves a farm and farmhouse to his son Michael with a right of residence to John’s wife Mary.
Michael inherits the farm less the value of the right of residence. On Mary’s death, John inherits the remainderman interest and becomes the absolute owner of the entire property
Discretionary trust – the trustee may pay or apply income or capital from a trust for the benefit of specified beneficiaries. Discretionary beneficiaries do not have an interest in trust assets and may not compel trustees to exercise its discretion in their favour.
Once all the principal objects of the trust are over 21, the trust is liable for:
- Discretionary Trust Tax at 6% of market value of the trust assets
- Annual 1% levy on the market value of the assets in each subsequent year
These taxes can be quite significant if the value of the trust is high.
The meaning of “discretionary trust for CAT” is wider than the strict legal definition. Any “power of appointment” can create a discretionary trust.
Cautionary Case Study
Care must be taken when drafting a Will to ensure that the Trust does not become a Discretionary Trust when this is not what was intended.
We had a case recently where the Will stated that that all of the property of the estate should be held in trust for the benefit of the disposer’s grandson until he reached the age of 25.
The Will went on to express the wish that any income from the property could be used for the benefit of the grandson until he reached the age of 25.
The insertion of this last clause meant that the trustee now had the power to apply income from the trust for the benefit of the grandson, this meant for tax purposes the trust was a discretionary trust.
Therefore the 6% trust tax applied in the first year and 1% thereafter until the grandson reached the age of 25.
The initial 6% tax was almost €30,000 – a significant sum.
There was no income from the property of the estate, nor was there likely to be. Perhaps the disposer envisaged there might be some rental income.
If tax advice had been sought at the drafting of the Will, there is no doubt that it would have been expressed in a different manner.
We hope you find this information useful. If you have any specific queries or require tax advice please don’t hesitate to contact us
We are tax advisers for accountants.