Taxation of Interest in Possession Trusts
The inheritance tax treatment of an IIP Trust has changed significantly over time, especially following the Finance Act 2006, which altered how these trusts are taxed for IHT purposes and brought many into the relevant property regime. The tax treatment of an IIP Trust depends on when and how it was created:
- Lifetime Transfers (created during your lifetime): Transfers into the trust are generally chargeable lifetime transfers (CLTs) for inheritance tax purposes. If the value of the assets transferred exceeds the nil rate band, an immediate IHT charge may arise. Some transfers may be classified as potentially exempt transfers (PETs) if certain conditions are met, but most IIP trusts use the CLT route.
- Created by Will (for a spouse or civil partner): No IHT is payable when the trust is created, when assets are distributed, or at anniversaries, provided the trust qualifies as an immediate post death interest for the surviving spouse. This makes IIP Trusts particularly effective for leaving assets to a surviving spouse while ensuring they eventually pass to your children or other beneficiaries after the spouse’s death (when the life tenant dies).
In all cases, trustees must consider capital gains, capital gains tax, income tax, and inheritance tax treatment for tax purposes, as well as the implications of passing assets, transferring chargeable assets, and the impact of the relevant property regime, transitional serial interest, and other legislative changes.
