Distributing an estate - income tax

Bobziz

Hi,

I'm the executor of my late mothers estate and would like to confirm my understanding of how I need to distribute her estate, including income generated after she passed, estate income.

The Will divides the estate into three equal shares and no IHT will be due. However, the estate will generate significant income after death, which will be taxed at 20%. For one of the three beneficiaries, their share of the estate generated income will push them into the higher rate tax bracket, and they will be required to pay a further 20% income tax.

A possible solution may be to distribute less estate generated income to the beneficiary who would be subject to higher rate income tax, but a larger share of the pre death estate. My assumption is that this would be classed as tax avoidance and therefore not permitted, is my assumption correct ?

Many thanks.

Hoenir

The estate of the deceased bears the income tax liability not the individual beneficiaries. A tax return will need to be completed and filed. 

Bobziz

Hoenir said:

The estate of the deceased bears the income tax liability not the individual beneficiaries. A tax return will need to be completed and filed. 

Thanks, it's my understanding that whilst the estate will pay tax at 20% on any income generated post death, unfortunately if when that income is then distributed it pushes any beneficiary into a higher tax bracket then further tax is payable by that beneficiary personally. Likewise, if the beneficiary has an income lower enough such that they incur no income tax, then they may claim some of the tax back which the estate has paid on their share.

poseidon1

Bobziz said:

Hoenir said:

The estate of the deceased bears the income tax liability not the individual beneficiaries. A tax return will need to be completed and filed. 

Thanks, it's my understanding that whilst the estate will pay tax at 20% on any income generated post death, unfortunately if when that income is then distributed it pushes any beneficiary into a higher tax bracket then further tax is payable by that beneficiary personally. Likewise, if the beneficiary has an income lower enough such that they incur no income tax, then they may claim some of the tax back which the estate has paid on their share.

You have stated the beneficiaries' respective tax positions on eventual distribution of estate income correctly.

As you will see from the HMRC  link below, each time you make a distribution on account of estate income ( less 20% or 8.75% tax depending on income source ) 
you are required to provide each beneficiary with form r185 which will show the gross, tax and net income to be reported on their respective self assessment tax returns. 

 If they are non tax payers they can potentially recover all the tax paid on their share. If basic rate tax payers then the  20%/8.75٪  r185 tax credit satisfies their obligations. If the distribution pushes a beneficiary into higher rate tax, then they still receive the 20%/8.75% tax credits with  further liabilities thereon to top them up to 40% or 45% . 

There are no legal means for the higher rate tax payer to avoid additional  income tax on their  income share unless of course they are prepared to disclaim their beneficial share of the estate in its entirety or execute a deed of variation diverting their share of the estate to someone else ( rather drastic measures to avoid income tax ).

What you have proposed as a solution would amount to tax evasion ( not tax avoidance ), and therefore illegal.

Depending on how long it will take to wind up the estate, you could of course make interim distributions of estate income each tax year, to avoid a cumulative amount distributed in the final year of winding up the estate.

Given there will be substantial income during the estate administration period and estate tax returns therefore required, hopefully you have access to professional help in preparing the requisite estate accounts detailing all estate capital and income transactions, culminating in the final beneficiary distribution accounts in due course. 


https://www.gov.uk/government/publications/trusts-and-estates-statement-of-income-from-estates-r185-estate-income

Bobziz

Thank you @poseidon1 that's a very comprehensive answer and confirms my understanding apart from the extent to which the proposal is a non-starter. 

Thankfully as all of the income is from a single source, the estate return will be simple and therefore no professional help will be required. 

I also have a plan b involving gift aid which should reduce the tax liability of the highest income beneficiary. As it will be gifts given by the beneficiaries rather than the estate, it will not be something that I need to act on in my capacity as executor.

Keep_pedalling

Bobziz said:

Thank you @poseidon1 that's a very comprehensive answer and confirms my understanding apart from the extent to which the proposal is a non-starter. 

Thankfully as all of the income is from a single source, the estate return will be simple and therefore no professional help will be required. 

I also have a plan b involving gift aid which should reduce the tax liability of the highest income beneficiary. As it will be gifts given by the beneficiaries rather than the estate, it will not be something that I need to act on in my capacity as executor.

How does that make the higher rate beneficiary better off? The gifts to charity would have to be greater than the tax saved. Nothing wrong with this solution if the aim is to divert some of the beneficiaries income and a smaller portion of HMRC’s revenue to charity, but if the beneficiary wants to hold on to more of the income for themselves then the better option is to pay it into a pension. 

Bobziz

Keep_pedalling said:

Bobziz said:

Thank you @poseidon1 that's a very comprehensive answer and confirms my understanding apart from the extent to which the proposal is a non-starter. 

Thankfully as all of the income is from a single source, the estate return will be simple and therefore no professional help will be required. 

I also have a plan b involving gift aid which should reduce the tax liability of the highest income beneficiary. As it will be gifts given by the beneficiaries rather than the estate, it will not be something that I need to act on in my capacity as executor.

How does that make the higher rate beneficiary better off? The gifts to charity would have to be greater than the tax saved. Nothing wrong with this solution if the aim is to divert some of the beneficiaries income and a smaller portion of HMRC’s revenue to charity, but if the beneficiary wants to hold on to more of the income for themselves then the better option is to pay it into a pension. 

It had always been the intention of the beneficiaries to make a substantial charitable donation. They had intended to do it by donating a third each. My suggestion is that the beneficiary subject to additional tax on the estate income pays the entire donation themselves and claims the tax back thereby offsetting some of the tax that they paid on their share of estate income. The other two beneficiaries then gift their share of the donation to the third beneficiary.

Keep_pedalling

Bobziz said:

Keep_pedalling said:

Bobziz said:

Thank you @poseidon1 that's a very comprehensive answer and confirms my understanding apart from the extent to which the proposal is a non-starter. 

Thankfully as all of the income is from a single source, the estate return will be simple and therefore no professional help will be required. 

I also have a plan b involving gift aid which should reduce the tax liability of the highest income beneficiary. As it will be gifts given by the beneficiaries rather than the estate, it will not be something that I need to act on in my capacity as executor.

How does that make the higher rate beneficiary better off? The gifts to charity would have to be greater than the tax saved. Nothing wrong with this solution if the aim is to divert some of the beneficiaries income and a smaller portion of HMRC’s revenue to charity, but if the beneficiary wants to hold on to more of the income for themselves then the better option is to pay it into a pension. 

It had always been the intention of the beneficiaries to make a substantial charitable donation. They had intended to do it by donating a third each. My suggestion is that the beneficiary subject to additional tax on the estate income pays the entire donation themselves and claims the tax back thereby offsetting some of the tax that they paid on their share of estate income. The other two beneficiaries then gift their share of the donation to the third beneficiary.

That is still tax evasion, it may also create IHT issues if any of the ‘gifting’ beneficiaries die within 7 years. The HR payer can easily avoid any additional tax by a combination of charitable giving and paying into a pension, perfectly legal and adds no complications for the other beneficiaries. 

Bobziz

Keep_pedalling said:

Bobziz said:

Keep_pedalling said:

Bobziz said:

Thank you @poseidon1 that's a very comprehensive answer and confirms my understanding apart from the extent to which the proposal is a non-starter. 

Thankfully as all of the income is from a single source, the estate return will be simple and therefore no professional help will be required. 

I also have a plan b involving gift aid which should reduce the tax liability of the highest income beneficiary. As it will be gifts given by the beneficiaries rather than the estate, it will not be something that I need to act on in my capacity as executor.

How does that make the higher rate beneficiary better off? The gifts to charity would have to be greater than the tax saved. Nothing wrong with this solution if the aim is to divert some of the beneficiaries income and a smaller portion of HMRC’s revenue to charity, but if the beneficiary wants to hold on to more of the income for themselves then the better option is to pay it into a pension. 

It had always been the intention of the beneficiaries to make a substantial charitable donation. They had intended to do it by donating a third each. My suggestion is that the beneficiary subject to additional tax on the estate income pays the entire donation themselves and claims the tax back thereby offsetting some of the tax that they paid on their share of estate income. The other two beneficiaries then gift their share of the donation to the third beneficiary.

That is still tax evasion, it may also create IHT issues if any of the ‘gifting’ beneficiaries die within 7 years. The HR payer can easily avoid any additional tax by a combination of charitable giving and paying into a pension, perfectly legal and adds no complications for the other beneficiaries. 

Thank you. Are you sure it would be classed as tax evasion? lf so then plan c, as you mention would be additional pension contributions.

Keep_pedalling

Bobziz said:

Keep_pedalling said:

Bobziz said:

Keep_pedalling said:

Bobziz said:

Thank you @poseidon1 that's a very comprehensive answer and confirms my understanding apart from the extent to which the proposal is a non-starter. 

Thankfully as all of the income is from a single source, the estate return will be simple and therefore no professional help will be required. 

I also have a plan b involving gift aid which should reduce the tax liability of the highest income beneficiary. As it will be gifts given by the beneficiaries rather than the estate, it will not be something that I need to act on in my capacity as executor.

How does that make the higher rate beneficiary better off? The gifts to charity would have to be greater than the tax saved. Nothing wrong with this solution if the aim is to divert some of the beneficiaries income and a smaller portion of HMRC’s revenue to charity, but if the beneficiary wants to hold on to more of the income for themselves then the better option is to pay it into a pension. 

It had always been the intention of the beneficiaries to make a substantial charitable donation. They had intended to do it by donating a third each. My suggestion is that the beneficiary subject to additional tax on the estate income pays the entire donation themselves and claims the tax back thereby offsetting some of the tax that they paid on their share of estate income. The other two beneficiaries then gift their share of the donation to the third beneficiary.

That is still tax evasion, it may also create IHT issues if any of the ‘gifting’ beneficiaries die within 7 years. The HR payer can easily avoid any additional tax by a combination of charitable giving and paying into a pension, perfectly legal and adds no complications for the other beneficiaries. 

Thank you. Are you sure it would be classed as tax evasion? lf so then plan c, as you mention would be additional pension contributions.

Yes, although one that is unlikely to be caught. The beneficiary should really stick to plan C which can also be used as a part of their IHT planning ( assets held in a pension are exempt from IHT) 

Savvy_Sue

The thing is, the tax positions of the various beneficiaries is their business, not yours as executor. 

Your job is to report and distribute. Theirs is to make a true return to HMRC.