Trusts Flashcards
Income tax – couples and partners
Marriage allowance saves couples £250.
Income from sa
- Unless the assets are redistributed early on in the tax year, transferring their ownership generally has its main effect on the income of future years.
- Transferring assets where the couple are not married or in a civil partnership may result in a CGT liability and a potential IHT liability. The potential liability to CGT may in particular make such a transaction unattractive.
- Transfers of assets between partners who are married or are civil partners are free of CGT, and the switch could save CGT when the assets are sold if one partner pays CGT at a lower rate, has an unused annual exempt amount or has unused capital losses. For such transfers to escape CGT, the couple must be living together in the tax year in which the transfer takes place.
Income from businesses and companies – basic planning
A higher income spouse or partner in business could pay the other spouse or partner a salary. Pay as you earn (PAYE) records must normally be kept (and real time information submissions made) even if the salary is below the NICs lower earnings limit of £120 a week in 2020/21. a salary between £120 and £183 a week will allow an individual to qualify for State benefits, such as the new State Pension, with little or no NICs being paid.
• Employer’s contribution could be paid to the spouse or partner’s personal pension plan.
• Profits could be shared by operating the business as a partnership. Both individuals need to be genuinely involved as business partners, and a written partnership agreement is highly desirable. However, there will be virtually no scope for reducing tax if the partnership’s business consists of supplying personal services in a form that is caught by the off-payroll working (IR35) rules so that employee treatment applies to most contracts.
If the business is set up as a limited company, a spouse/partner could become a shareholder and receive dividends (again, there is virtually no scope for reducing tax if a company is caught by the off-payroll working rules).
• The first £2,000 of an individual’s dividend income is taxed at 0%. It is generally worthwhile to pay a spouse or partner up to £2,000 of dividends, or more if their other income is less than their personal allowance.
• An individual whose income is within the basic rate tax band, after taking account of the £2,000 dividend allowance, has 7.5% tax to pay on dividends.
• Unlike salary, dividend income is not subject to NICs.
Income tax – children
Teenagers can work in a parent’s business for a salary as long as the payment is reasonable for the work done. No tax is payable, provided that it falls within their personal allowance.
• Where a child is a beneficiary of a discretionary trust that has not been created by a parent, the trustees can distribute income and the child can reclaim the 45% tax paid on the distribution.
• For many parents, the parental gift rule does not have any negative tax implications because the additional income will be covered by the personal savings allowance or the dividend allowance.
Children who do not have a CTF can hold one cash and one stocks and shares Junior ISA at any time. The overall annual contribution limit is £9,000 for 2020/21. Funds in Junior ISAs are ‘locked in’ until the child is 18, when the accounts will become adult ISAs by default.
Child Tax Credit
The fact that the £50,000 or £60,000 thresholds have remained unchanged since the introduction of the high income child benefit charge in 2013 is an example of how fiscal drag can push taxpayers into higher tax brackets.
• Many people who become subject to the high income child benefit charge do not realise that they have to notify HMRC of this fact. This is particularly relevant for people who do not normally make tax returns because their income is taxed under PAYE. HMRC does not routinely combine information about child benefit claims with details of the income of both spouses or partners. When HMRC eventually does impose the high income child benefit charge, sometimes after several years of liability, the taxpayer will generally also be charged penalties for failure to notify chargeability.
Income tax – directors and employees
- They might be able to choose to take a bonus or dividends, either before or after the end of the tax year, depending on their tax rate in each year.
- An individual who is an additional-rate taxpayer in one year may not be in another, so depending on their circumstances, it may be possible to delay a large dividend until after the end of the tax year. This could delay the payment of additional rate tax for a year, although the benefit of deferral is limited if dividends are paid every year.
- Anyone who holds share options should consider the tax position (as well as the investment issues) when deciding whether to exercise them now or in a future tax year. CGT may be at 10% or at the higher rate of 20%, depending on whether the gain or part of it falls within the individual’s basic rate band in the year of exercise.
- A director who is also a major shareholder in a company may be able to reduce NICs by taking dividends instead of remuneration. With the rate of corporation tax at 19% for the financial year 2020, dividends are generally preferable regardless of company profit levels. The benefit is greatest where dividends fall within the shareholder’s £2,000 dividend allowance. To the extent that dividends fall within the individual’s higher or additional rate bands, the overall tax advantage of dividends compared with salary (considering the company and individual together) is small.
- Personal service companies and partnerships are subject to special rules that mean they cannot generally save tax by paying dividends or by employing a partner. If a business is affected by the off-payroll working (IR35) rules, paying sufficient salary will avoid the complications that can arise from being taxed on a ‘deemed payment’. Company pension contributions remain fully allowable provided the contributions are made ‘wholly and exclusively for the purposes of the trade’. Where the off-payroll working rules apply to a contract with a public sector body, there is no scope for any planning because payments under the contract are subject to PAYE and NICs at the time of payment. The Government will extend this tax treatment to the private sector from 6 April 2021. As with the public sector, the responsibility for paying the correct employment taxes will then move from the personal service company to the business or employment agency engaging the contractor. There will, however, be an exemption for services supplied to smaller businesses.
- The taxable benefit resulting from the use of a company car is usually chargeable only for the period for which that car is available to the employee and so, a change in car during the tax year has an immediate effect on the benefit. The same is true for the additional tax charge on fuel provided for private mileage in a company car. Given the low percentage charges that have been introduced from 6 April 2020 for hybrid-electric cars with CO2 emissions between 1 and 50 g/km, with a 0% percentage charge for cars that can only be driven in zero-emission mode, it is worth seeing whether a company car should be replaced with a more tax beneficial model. New cars with CO2 emissions up to 50 g/km also (for 2020/21) qualify for capital allowances at the rate of 100%, so effectively are a deductible expense in the year of purchase for the employer.
Income tax – self-employed people
The choice of accounting date can make a difference to the timing of tax payments on business profits. A change of accounting date can also enable overlap relief from earlier years to be used before inflation erodes its value.
• The date on which a self-employed person retires or ceases self-employment can make a difference to the tax liability in the final tax year of the business.
• Although recent tax changes have reduced the attraction of running a business through a limited company, there can still be a tax advantage compared with operating as a self- employed individual or partnership. The timing of any change to company status may affect tax liabilities, although the decision will depend on many other factors as well – such as turnover and the increase in administration costs of running a limited company.
National Insurance contributions planning
The qualifying period for the maximum State Pension is 35 years.
Benefits based on contributions
The following benefits depend on an individual’s (or partner’s) NICs record:
• the new State Pension;
• new style Jobseeker’s Allowance (class 1 NICs only);
• bereavement payments;
• contribution-based Employment and Support Allowance (ESA); and
• Maternity Allowance.
NIC Planning:
Taking dividends instead of salary from a company in which they have shares and for which they work. Dividends do not count as earnings for NIC purposes. To the extent that dividends fall within the £2,000 dividend allowance, there is a significant saving (taking into account the company’s and individual’s tax, and NICs liabilities together) compared with paying salary, and a somewhat lesser saving when tax is at the basic rate. The saving is very small at the higher and additional rates, which limits the benefit of this strategy.
• Increasing the amount the employer contributes to company pension schemes by salary sacrifice. Employer pension contributions are not earnings. This strategy may be constrained by the pension annual and lifetime allowances.
Pension planning
The value of the tax relief on pension contributions is greatest where the tax relief on the contributions is greater than the tax on the benefits. So, there is likely to be some tax advantage simply because the tax-relievable contributions generate a fund from which the member can eventually draw 25% as a tax-free cash lump sum.
– There is a greater advantage in the unlikely event that the pension income is tax free, or more probably, that the contribution benefits from 40% or 45% relief and the pension income is then taxed at 20%.
– NIC relief is often overlooked. Employers’ contributions and pension benefits are not subject to NICs.
- The tax position of the pension fund is essentially the same as the tax position of ISAs and offshore bonds. The differences lie in the tax treatment of the initial investment and the encashment proceeds of these various plans. However, for a basic-rate taxpayer, the Lifetime ISA effectively provides the same tax relief on initial investment as pension savings, but with tax-free withdrawals. It may therefore be a more attractive approach to retirement saving for some individuals.
- Making pension payments up to the amount of the contributor’s income that is subject to higher and additional rate tax (if possible, given the tapered reduction) will maximise the benefit. Where a person makes pension contributions net of tax at 20% it is the grossed- up payment that should not exceed the income that is subject to higher or additional rate tax.
- It is possible to contribute up to £3,600 gross in a tax year to a registered pension scheme for a partner or children with little or no earnings, so the contributions benefit from tax relief at 20% (2020/21), even if the individuals themselves do not actually pay any tax.
Pension contributions that have the effect of removing dividends from the higher rate tax bracket can produce tax relief at an effective rate of 45% in 2020/21. Higher-rate taxpayers who make a pension contribution save tax at 45% to the extent that their basic rate tax band is extended so that it covers their dividend income. The saving consists of the 25% difference between the higher (32.5%) and basic (7.5%) tax rates on dividend income, and the 20% basic-rate tax relief deducted from the pension payment. There is no similar enhanced saving where pension contributions have the effect of removing dividends from the additional rate to the higher rate. A similar result can be achieved by claiming other reliefs that reduce taxable earnings.
• Pension contributions may also impact on CGT liabilities because they will increase a person’s basic rate tax band, and therefore reduce the amount of gains taxed at the higher CGT rates of 20% (or 28% for residential property gains).
Non-UK-domiciled spouse or civil partner
There is a restriction on the IHT spouse or civil partner exemption. The exemption is limited to £325,000 if assets pass to a spouse or civil partner who is not domiciled (or deemed domiciled) in the UK for IHT purposes.
One way to deal with this situation is to make outright lifetime transfers to the non-UK- domiciled partner, which will rank as potentially exempt transfers (PETs) and insure the potential IHT liability for the seven-year period. Alternatively, the non-UK-domiciled spouse or civil partner can elect to be treated as UK domiciled.
This will mean that transfers of any amount will be wholly exempt for IHT purposes, but the electing spouse or civil partner’s worldwide assets will then be subject to UK IHT. An election to be treated as UK domiciled can be made during lifetime or on death.
Spouses or civil partners making an election during lifetime or on death can choose UK- domiciled status to apply from any date within the previous seven years. Any lifetime gifts made during that period will then be covered by the election.
Elections that are made after the death of a UK-domiciled spouse or civil partner must be made within two years following the death (unless HMRC agrees to a longer period). An election in these circumstances must be made on behalf of the non-UK-domiciled individual by their personal representatives.
Residence nil rate band
The RNRB is only available where a residence is inherited by direct descendants. It is not usually available where a property is left to a discretionary trust, but will potentially be available if a property passes to a trust with an immediate post-death interest, a trust for a disabled person or a trust for a minor. It may be necessary to rewrite a will so that the RNRB is available.
• The value of the residence is after deducting any repayment mortgage or interest-only mortgage secured on that property. It may therefore be beneficial to repay such a mortgage before death because if a residence is valued at less than the available RNRB, then the RNRB is reduced to the value of the residence.
• The availability of the RNRB is protected where an individual has downsized or ceased to own their home after 7 July 2015, but only if assets of an equivalent value are passed to direct descendants – so this should be written into a will.
• If an estate does not contain a residence, it may be worthwhile for an individual to buy one – there being no minimum ownership period.
• There is a tapered withdrawal of the RNRB for estates with a net value of more than £2m (after deducting any liabilities but before reliefs and exemptions). An individual could reduce the value of their estate to less than £2m by making lifetime gifts – even if such gifts are made immediately prior to death and therefore carry no other IHT advantage.
Potentially exempt transfers
PETs may provide individuals with valuable tax-saving opportunities if they can afford to make gifts of substantial amounts, usually to their families. The main advantage of a PET is that there is no lifetime IHT charge regardless of the amount gifted. Therefore, even if the gift causes the nil rate band to be exceeded it will not incur the lifetime IHT charge of 20% on the excess. Of course, if the donor does not survive the seven-year PET period, IHT may be payable if the amount gifted is not covered by the donor’s nil rate band. For gifts in excess of the nil rate band that become taxable, taper relief may be available if death occurs after three years of making the gift.
It is important to consider any CGT consequences of gifts. A gift to a spouse or civil partner will be a no gain/no loss disposal provided the couple is living together, whereas a gift to any other person will not be.
• A seven-year level term assurance policy could be taken out to cover the potential IHT liability on the death estate if the donor dies within seven years of making a PET. If a PET is made that causes the nil rate band to be exceeded, any potential liability to IHT on that excess could be covered by a form of decreasing term assurance over that period.
• Several factors must be taken into account when considering possible PETs of business or non-business assets:
Whether the assets produce income that is needed.
– The level of business relief on gifts of such shares or other business assets.
– The availability of CGT holdover relief for gifts of business interests. CGT is chargeable on a gift of an asset as if the asset had been transferred at market value. If holdover relief is available, the CGT is, in effect, deferred until the donee disposes of the asset. However, the combined IHT and CGT position might still be better if the transfer were made on death when, currently, there would be no CGT and 100% IHT business relief may be available.
– Whether the client should maximise their pension provision before making a gift of private company shares or other business assets.
Lifetime transfers into trusts other than bare trusts…
are usually chargeable lifetime transfers (CLTs), not PETs. Thus, for most practical purposes, only an outright gift to an individual can be a PET, with a corresponding loss of control.
Chargeable lifetime transfers
The combined effect of the nil rate band and the seven-year cumulation rule can provide valuable planning opportunities. Nil rate band discretionary trusts could theoretically be established every seven years with no immediate – and possibly no subsequent – charges to IHT.
• In practice, discretionary trusts are well suited to those circumstances where the tax advantages of removing an asset from an estate are evident, but where the eventual beneficiary has not been chosen at the time of the transfer.
• It is tax efficient to transfer those assets that are most likely to appreciate in value, because the capital appreciation is not chargeable to IHT on the donor (for example, shares in a new business venture).
• Where appreciating assets are put into a discretionary trust, the trust will need careful monitoring in order to take advantage of any opportunities to avoid or reduce the periodic (ten-year) and exit charges.
• Chargeable gains on transfers into and out of trusts may be subject to an election for CGT hold-over relief. In some circumstances, this may be a reason to make a chargeable transfer rather than a PET.
