US Revocable Trusts – Inheritance Tax traps for the unwary
A common form of estate planning in the US is for an individual to create and fund a Revocable Trust (sometimes referred to as a Living Trust or a Living Will). However, structures of this nature can be problematic for anyone with connections to the UK.
US Revocable Trusts are popular in the US because they represent a relatively simple means of avoiding probate following death. Typically, the Grantor (i.e. the Settlor) will have a right to all income together with a right to access capital on request. The Grantor will have significant retained powers (such as a power of revocation) and will often be the sole trustee during his or her lifetime. The terms of the Trust then set out how assets should devolve following the Grantor's death. The structure is entirely tax neutral for US purposes with the assets being taxed as if they belong to the Grantor directly.
For individuals with connections to the UK, the analysis is not so straightforward. Significant UK Inheritance tax (IHT) complications can arise if:
- The Grantor is domiciled in the UK because any assets they contribute into a lifetime trust may incur an immediate 20% entry charge to IHT followed by ten year anniversary charges to IHT at rates of up to 6% (subject to available nil rate band allowance); or
- The Grantor is not domiciled in the UK but contributes UK situated assets to their Revocable Trust as there may be a 20% entry charge to IHT on the value of those UK assets followed by ten year anniversary charges at rates of up to 6% (subject to available nil rate band allowances).
From a UK perspective the difficulties outlined above lie in the way IHT is levied under the ‘relevant property' charging regime applicable to trusts. The potential tax exposure can be significant, so we would never advise a client to create and fund a Revocable Trust arrangement if either of the above scenarios apply.
For those that have already set up Revocable Trust structures, all is not lost. Depending on the specific drafting it may be possible to argue that a Revocable Trust should be treated for UK purposes as a ‘bare trust’ or ‘nominee arrangement’. A crucial distinction exists because bare trusts and nominee arrangements are not within the relevant property regime, with the result that the adverse IHT implications referred to above are avoided. Essentially, we may be able to argue that there is not a taxable trust for UK purposes.
The drafting of each US Revocable Trust is unique, with the result that a thorough examination of the drafting is needed before a view can be taken on whether or not the UK’s relevant property regime applies. In carrying out an analysis, some of the key issues we examine are the extent of the Grantor's retained powers, the governing State law of the trust Instrument and whether the trustees owe fiduciary duties to any other beneficiaries during the Grantor’s lifetime. Commonly, difficulties can arise in the way the provisions of a US Revocable Trust deal with the future incapacity of the Grantor.
If UK tax issues are identified we can help clients make appropriate amendments to their structure or assist with unwinding the trust in a UK tax efficient manner. It is important to be aware that the UK tax analysis of a Revocable Trust should not stop with a review of the IHT implications. There are additional income tax and capital gains tax implications that are equally important to take into account where there are Grantor, trustee or beneficiary connections to the UK.