US Revocable Living Trusts (or Living Will Trusts) are a commonly used estate planning tool in the US because they help to avoid costly and lengthy probate processes. However, these types of trusts can be problematic for UK connected individuals and potential issues are not always immediately apparent.
Issue 1: Is a US Revocable Living Trust a ‘settlement’ for UK tax purposes?
‘Settlement’ is not a precisely defined term for UK Income Tax and Capital Gains Tax purposes. A trust, such as in the case of bare trusts, may not meet the definition of a UK settlement.
The UK Inheritance Tax (IHT) definition of ‘settled assets’ is far reaching and although HM Revenue & Customs (HMRC) have confirmed that a bare trust is not a settlement for IHT purposes, US trust laws generally do not respect the concept of a bare trust. So where does that leave us? A review of the Revocable Living Trust deed on a case-by-case basis is an important starting point in determining whether the trust is, or is not, a settlement for UK tax purposes.
Issue 2: What if the sole Trustee is a UK resident?
If you are the sole UK resident Trustee of a Revocable Living Trust which does not qualify as a bare trust for UK tax purposes, then the trust will be a UK-resident trust and have UK tax filing obligations.
The Trustees may also have an obligation to register under the UK Trust Registration Service (even if a bare trust).
Issue 3: Changes in classification
The status of a Revocable Living Trust, which is classified as a bare trust, may change on certain later events.
Commonly this occurs on the death of the grantor as they simply will no longer be able to revoke the trust. It can also occur at the loss of the grantor’s mental capacity, as the grantor loses their ability to revoke the trust (although this may vary from State to State).
At best, a change in classification will create additional complexity and reporting requirements for the Trustees. At worst, for an individual who is domiciled or deemed domiciled in the UK at the point of loss of capacity, there could be a 20% IHT trust ‘entry tax charge’ on the value of the trust’s assets.
Issue 4: What if I am a UK resident and the beneficiary of my relative’s Revocable Living Trust?
If you are due to inherit assets from a Revocable Living Trust on the passing of a relative, then it is important to review both the initial status of the trust and what happens to the assets on your relative’s passing. Commonly we will explore:
- Whether it is a bare trust until death
- Whether there was a loss of capacity prior to death
- What happens to the assets after death and whether the trust continues, tips over into a new trust or passes directly to you
A bequest which is received directly from an individual is free of UK taxes, however, a distribution from a non-UK resident trust is taxable on a UK resident recipient at rates up to 45%. This assumes that there is accumulated income and/or realised gains within the trust to match to the distribution and this can sometimes span decades.
In summary
Forewarned is forearmed – we would advise UK resident grantors or beneficiaries of a Revocable Living Trust to have the terms of their trust reviewed by an expert so that they can understand what the trust is for UK tax purposes, what impact that currently has for them and whether any planning can be undertaken to improve the position.
If possible, this review should be undertaken prior to an individual becoming a UK resident. Taking advice whilst a resident may also improve an individual’s current position and we are experienced in helping individuals navigate this complex area.
