Trusts as an estate planning tool

Monthly Accounting & Tax Compliance

Introduction

Wealthy individuals and families sometimes use trusts as an estate planning tool. Trust founders establish trusts for a specific purpose, like for a social welfare project, or for the benefit of a beneficiary.

General functioning of a trust

A trust founder creates a trust and then appoints trustees to act in a fiduciary capacity. The trustees play an important role in the administration and management of trust capital and funds. The assets held in the trusts generate income and capital for the trust. The trustees may distribute this then to the trust beneficiary or towards a specific purpose. 

Trusts function as their own legal “person” and any taxable income that is attributable to the trust will be taxed at the income tax rate set out for trust. Any income or capital that the trust, therefore, does not distribute. will be taxed in the trust.

Different types of trusts

Inter vivos-trust

An Inter Vivos trust is created during the lifetime of a trust founder and also is the mechanism most commonly used as an estate planning tool. In many instances, the trust will receive a donation, and specific tax consequences apply to this donation.

Mortis causa-trust

Creating a trust according to a will after the death of a person is called a Mortis causa-trust. The purpose of this type of trust is to be a mechanism to look after the family of the deceased. Assets are usually bequeathed, in line with the will of the deceased, to the trust. 

Trust from a tax perspective

A special trust

In brief, the tax rates that apply to a special trust will be based on the progressive tax scale that is applicable to individuals, the lowest tax rate of which is currently 18%. There are two categories of special trusts and they are trusts that are:

  1. In accordance with the will of a deceased, a trust should be formed – given that specific conditions have been met
  2. For a person with a disability with the sole purpose of providing for that person, also with specific conditions attached.

A general trust

Trusts are regarded as a general trust if the trust does not fall within the definition of a special trust as described in s1 of the Income Tax Act 58 of 1962. The current tax rate for general trusts is 45%.

Conclusion:

You will have to give specific attention to the tax consequences of the donor and founder of the trust. It may be that the trust income and capital distributed to the beneficiaries will be taxable in the donor’s hands in accordance with s7. S7C has been implemented as an anti-avoidance measure to reduce the impact of specific circumvention of estate and/or donations taxes and should be carefully considered.

If you need tax advice on trusts, get in touch with us here.

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