Problems with US Trusts When UK Domiciled

The UK and the US have different approaches to trust taxation, which means that if you have a foot on both sides of the Atlantic, one-sided estate planning that seems to provide a tax efficient solution in one country may actually cause a tax bill in the other.

Complications can occur when Americans staying in the UK become domiciled, or invest in UK property (or vice versa). Benefitting from or establishing a trust with transatlantic property or beneficiaries will also cause issues, but an often overlooked hazard is estate planning with only one country in mind – especially given the mismatch between US/UK estate taxes.

From the US perspective:

Probate in the US is a costly, time consuming and notoriously complex process. In order to save fees and heartache US estate practitioners often recommend putting in place a 'living trust'. Created during the settlors' lifetime (or grantor in US terms) this arrangement puts assets outside of their estate and therefore outside the probate system. It is also 'transparent' for US tax meaning the grantor is taxed on the assets as if they owned them.

Another common US estate planning measure for US/UK married couples is the 'qualifying domestic trust' (QDOT). These are intended to mitigate the risk of incurring both US and UK estate tax liabilities following the death of the first spouse – potentially two sets of death duties. The QDOT mitigates this; the effect of the US tax laws on these trusts means they are generally only subject to US estate tax when the second spouse dies, at which point the US/UK estate duties can be offset against each other.

From the UK perspective:

The standard living trusts recommended in the US can, however, cause a substantial UK Inheritance Tax (IHT) liability. If the settlor is domiciled or deemed domiciled in the UK these living trusts will be subject to the UK trust taxation regime whereby:

  • there is an immediate 20% charge to IHT (on any transfer to trust over £325,000).
  • subsequent IHT charge of up to 6% is due every ten years and when assets are transferred out the trust.
  • a potential 40% charge to IHT if the settlor dies within 7 years of creation (though this tapers the longer the settlor was alive, and credit is given for the initial 20% payment).

Most married couples will own their homes jointly. This is a risk if one spouse is a US and one is a UK citizen, as US estate tax can arise on the death of the US spouse, and UK IHT on the death of the UK spouse. QDOTs are a necessary step in this scenario, as they will help prevent double taxation of jointly owned property.

Joining them up:

There are ways to plan effectively for both sets of taxes but it requires some thought about how you would like your estate to pass, whether a trust arrangement would work for you, where to hold your assets during your lifetime and the impact of life events such as a new job, a relocation or marriage and a family.

If you've assets in both countries, have married, or moved, or all three, it is important to think about your existing will and property arrangements and obtain advice on how to synchronise them.

What is the solution?

The intersection of US/UK tax and trust law is a complex area, and we have the expertise to review, advise on and implement practical solutions. We have close connections with US advisers, and a detailed knowledge of this area which means the estate planning team here can speak both US and UK trust law languages.

If you have US estate planning in place but are UK domiciled or deemed domiciled, we can review existing arrangements, identify potential issues and suggest solutions. If you're in the process of US estate planning we can work alongside your advisers to ensure your planning can span the Atlantic.