02 August 2016

What is a Living Trust?

A Living Trust, as the name implies, is a trust which is created during a person's lifetime. This is in contrast to a Testamentary Trust, which is a trust created after a person's lifetime through the operation of that person's will.
Typically the person who settles the trust (the "Grantor") will retain extensive control powers over the assets in the trust, including the right to take back or "revoke" the assets during his or her lifetime. These forms of Living Trusts are known as "Grantor Trusts" in the US.

What is the advantage of a Living Trust in the US?

US attorneys and accountants frequently advise their clients to settle assets in a trust in order to circumvent probate, since trust assets do not form part of a person's probate estate. Probate in the US is reputed for being slow, costly and lacking privacy.

There may also be tax motivations for settling a trust. For example, if you die and your spouse is not a US citizen or green-card holder, there may be a substantial US Estate Tax liability at the time of your death. If your spouse is a UK domiciliary, there may also be a UK Inheritance Tax charge when they subsequently die – meaning your estate will have been subject to two different sets of death duties.

To avoid US Estate Tax being payable on the first death, you may be advised to settle your assets in a "Qualifying Domestic Trust" or "QDOT". Assets settled in a QDOT will only be subject to US Estate Tax when the second spouse dies. If there is also UK Inheritance Tax to pay at that time, you may be able to credit the US Estate Tax against the UK Inheritance Tax.

Problems for UK domiciliaries

Many UK domiciliaries with assets in the US are told to settle Living Trusts. However, those who do so without first taking UK advice may find themselves inadvertently triggering substantial tax liabilities in the UK.

If a Living Trust qualifies as a Grantor Trust it is treated as "transparent" for US tax purposes. This means that the Trust is effectively "tax neutral", since for US income tax purposes the Grantor is taxed as if he owns the trust assets.

However, the UK has a substantially different approach to taxing trusts than the US. In particular, transferring assets to a revocable trust during one's lifetime can give rise to:

  • an immediate UK Inheritance Tax charge of 20%
  • UK Inheritance Tax charges of up to 6% every ten years and when assets are taken out of the Trust
  • UK Inheritance Tax of 40% when the Grantor dies.

These charges may apply if the Grantor is either domiciled or "deemed-domiciled" in the UK. It does not matter where the assets are located.

How can we help?

If you are considering putting in place US estate planning and are domiciled, deemed-domiciled or resident in the UK, then you should ensure that the planning is reviewed by a UK lawyer. You should also consult a UK lawyer if the assets to be put into the trust are UK-situated.

We have many clients with US connections and work closely with US lawyers to ensure that both the UK and the US angles are covered. If your US advisor is suggesting that you settle a QDOT, for example, we might propose that this be contained in a will rather a Living Trust. We would then review the will and ensure that it ties in with any UK will and other succession planning.

If you have already settled a US trust without taking UK advice, we can review the position to make certain that there are no UK tax or succession issues. If we identify any problems then we can help fix these.

Key contact

Suzanna Harvey Partner

  • Head of Private Wealth
  • Private Client Services
  • International Tax

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