FAQ about Trust Costs, Assets, Taxes, and Profit Distribution

A Trust is a popular asset protection as well as estate and inheritance planning legal mechanism. Trusts come in different types and some of them are efficient in protecting your property from foreign creditors and courts of law while others serve the purpose of preserving family assets very well. A trust is also a handy tool of distributing wealth among the family members. 

A large number of our clients wonder how trusts can be used, what benefits can a trust bring, and what difficulties may be associated with setting up and maintaining a trust. Does money in a trust count as an asset? Is trust income considered earned income? What expenses can be paid from a trust? We answer these and other related questions in the text below.

What types of trust relationships exist?

There are various types of trusts: discretionary trusts, bare trusts, revocable trusts, irrevocable trusts, corporate trusts, and so on. Depending on the trust relationships that have been established, the trust Settlor, the Trustee, and the beneficiaries enjoy different rights and capabilities as far as profit distribution is concerned. The same holds for the trust management routines as well as the opportunity to introduce changes to the trust agreement.

With the view of your main goal, you can choose to create a trust of one of the following types: 

1. To protect your assets from sanctions, creditors, and foreign courts of law, you should set up an irrevocable trust in a foreign jurisdiction. In this case, the Trustee is going to be the property manager and the Settlor is not in a position to change the articles of the Trust Deed nor the list of assets held in trust. We must note that it can be possible to do so if the Settlor is simultaneously the Trustor and the trust beneficiary. However, holding all three positions at a time is not efficient in terms of asset protection. For this reason, most irrevocable trusts have trustees that are different from the trust settlors. In this case, the property in trust is legally separated from the Settlor and the Trustee becomes the legal owner and manager of the assets. More often than not, a legal firm acts as the Trustee rather than an individual person.  
2. To plan your inheritance, you can create a fixed interest or a purpose trust. The Trust Deed will specify if your property shall be distributed to your heirs in your lifetime or after your death. The same document will spell out how long the trust is going to exist. 
3. To support a legally incapable person, you can create a charitable trust. In this case, the trust beneficiary has to be a disabled person who needs care, an underage child whose tuition needs to be paid, or any other vulnerable individual who requires financial support. Charitable trusts are entitled for various tax deductions.
4. To accumulate income and lessen the tax burden, you can create a revocable or an irrevocable offshore trust. You can make it a discretionary trust, which will mean that the Trustee will manage the property at their discretion in accordance with the guidelines specified in your ‘letter of wishes’. With a non-discretionary trust, these guidelines can be spelled out in the Trust Deed.

There are many reasons why trusts are created and there are many different types of trusts each serving a particular purpose. In the text below, we will dwell mostly on the following questions: What taxes do trusts pay? How does money come out of a trust? Can a beneficiary withdraw money from a trust? And the like. 

Should you open a trust at home or abroad?

Again, the answer to this question will depend on your main goal. In some cases, it would make sense to create a trust in your home country while in other cases, you had better register an offshore trust.

1. Domestic trust – is a trust created in the country of the Settlor’s citizenship and/ or legal residence. A domestic trust can be created if you pursue one (or several) of the following goals:
   • Inheritance planning. If your bank accounts, real estate, and other assets are not under sanctions and if you have no tensions with your home country’s fiscal authorities and law enforcement agencies, you can create a domestic trust to hand down property to your heirs.
   • Domestic asset protection. People often create domestic trusts if all their property is located in their home country. A member of the family or a close friend usually acts as the Trustee in such a trust.
   • Support to minors or elderly family members. A charitable domestic trust can be used to finance children’s education, elderly parents’ healthcare, and other similar purposes.
2. Offshore (foreign) trust – is a trust registered in a foreign jurisdiction. An offshore trust can be used to protect your property located in different countries from creditors, overspending relatives, and court decisions. If you are interested in creating an offshore trust, we suggest that you should consider the following jurisdictions first of all: Nevis, the Cook Islands, Belize, the BVI, and Malta.  

What expenses can be paid from a trust?

When setting up a trust, you can determine how the assets kept in trust can be used by you as the trust Settlor, by the Trustee, and by the Beneficiaries. Trusts have bank accounts and the money in the accounts can be used to cover the following costs:

• utility bills; 
• insurance premiums; 
• property taxes and other property-related payments; 
• funeral services when the Settlor dies; 
• legal services;
• trust maintenance costs (in reasonable amounts)
• settlement of debts made by the Settlor or a Beneficiary (in some cases).

Please note that the Trustee can withdraw money from the trust account for his/ her own purposes only if the Trustee is simultaneously the Settlor and the Beneficiary. 

Can a trust be profitable?

Yes, it can. The property or the business company held in trust can bring profits. The trustee company manages the property, conducts business operations, makes investments, trades in securities, and then distributes the profits to the beneficiaries.

Any trust that makes profits has to have a bank account. Normally, a trust will have one of the following types of bank accounts:

• Savings account – to earn on the interest;
• Broker’s account – to trade in securities;
• Investment account – to invest the assets in trust into various projects.

Please learn more about trust bank accounts by following the link.

Is trust income considered earned income?

The assets put in trust are not considered an income or a profit of the trust. If the assets in trust are invested wisely, then a profit may arise. If the property held in trust is sold, an income will arise too.

If the trust is a commercially active organization, if it makes investments and the business activities result in profits, then they can be distributed among the trust beneficiaries. Otherwise, the income can be accumulated in the trust for further investments, business expansion, or other purposes.

Please note that the undistributed profit made by a trust is often taxed. The owner of the assets (that is, the Trustee) pays the taxes.

What taxes are payable by trusts?

You may have heard that trusts are 100% tax exempt. This is not exactly correct. Some countries levy taxes on trusts. The tax rates and types depend on the type of the trust. 

Foreign trusts can be taxed in the following cases:

• If the trust keeps the profits after the end of the fiscal year, the income is taxed. 
• If the profits are distributed to the trust beneficiaries, the tax obligations are passed on to the beneficiaries. The tax rate depends on the type of profits that have been distributed. For example, the beneficiary is not taxed when last year’s profits are distributed to him/ her because the trust had already paid the taxes last year. 
• Trusts are not double-taxed. If all the profits made by the trust are distributed to the beneficiaries, the trust is not taxable. In this case, the beneficiaries pay the taxes. If the profits are not distributed to the beneficiaries, the trust is taxed while the beneficiaries are not.

Taxes on trusts in Great Britain

The following types of trusts are NOT taxed and NOT registered for TSR in Great Britain and most other countries:

• Charitable and pension trusts;
• Trusts created on the deceased person’s Last Will if the trust is not more than two years old since the Settlor’s death.
• Trusts whose assets are distributed in case of the Settlor’s death or critical illness;
• Trusts created after October 6, 2020 if the value of the assets is less than 100 pound sterling;
• Joint trusts if the legal and the factual owners of the assets are the same persons;
• Trusts created for handicapped people and other vulnerable beneficiaries such as orphans or elderly people.

In some other cases, however, the Trustee or the trust beneficiaries may have to pay taxes. 

The trustee of discretionary accumulation trust is taxed at 7.5% to 20% on the first 1,000 pounds of profits, and he/ she is taxed at 38.1% to 45% on the profits exceeding 1,000 pounds.

If a bare trust is registered in Great Britain, the beneficiaries have to pay the taxes.

Taxes on trusts in the USA

The IRS may oblige the trust registered in the country and/ or the Settlor to file tax returns and pay taxes. At the same time, some tax deductions are available to trusts in the USA. These can be used when the profits are distributed to the beneficiaries, when the money goes to charity, or when gifts are made (applicable to gifts of up to 12.92 million dollars for a single person and up to 25.84 million dollars for a married couple). In addition to that, trust management costs are deducted from the tax base (in reasonable amounts).

Can a beneficiary withdraw money from a trust?

Beneficiaries can withdraw money from a trust under certain conditions:

1. If the beneficiary is simultaneously the trust Settlor and the Trustee. 
2. If the Trust Deed allows the beneficiary to withdraw money on request or in certain circumstances.
3. If the trust is liquidated or it ceases to exist due to the Settlor’s death or for some other reasons. 

In all other cases, the trust beneficiary cannot withdraw the money kept in trust at his/ her own wish.

How does money come out of a trust?

The answer to this question also depends on the type of the trust. Normally, the profits are distributed as follows: the trust opens a bank account with the Trustee acting as the account holder. When the trust makes a profit, it is transferred to the trust account and then it is distributed to the beneficiaries via transactions to their bank accounts. The Trustee can also use the trust account to cover the trust maintenance costs. The procedure of money distribution has to be clearly described in the Trust Deed.

The Trustee can also withdraw money from the trust account to cover the costs of a trust beneficiary. This is possible when the beneficiary is below legal age or he/ she is legally incapable due to a disability or he/ she is not a trustworthy person known for frequently overspending.

Does money in a trust count as an asset?

No assets held in trust including real estate, bank accounts, works of art, and so on are considered property of the trust, from the legal point of view. 

The term ‘trust’ refers to a fiduciary agreement between parties. A trust is not a legal entity in the same sense as a corporation, for example, is a legal entity. A trust cannot own assets, make business contracts or enter any other legal agreements in any way.

The ownership rights for the property kept in trust belong to the Trustee. Depending on the type of trust, several factors can play a role in this respect.

For example:

• The Trustee controls the property in bare trust but the beneficiary is entitled to claim the property when he/ she reaches legal age.
• If the trust is discretionary, the Trustee is entitled to distribute the assets in trust to the beneficiaries in the ways that he/ she deems appropriate.
• If the trust is irrevocable, in addition to the Trust Deed, another document is usually issued, namely, the Letter of Wishes. The Letter describes how the trust Settlor wishes the assets to be managed and profits distributed.

Because the trust is not the legal owner of the assets, it doesn’t normally have to pay taxes. On the other hand, the Trustee can be liable to taxes as the asset owner. The beneficiaries of the trust have tax obligations when they derive an income from the trust.