How to navigate the £500 trust income exemption

The introduction of a £500 income exemption from 6 April 2024 will impact many trusts. It comes with various complications, especially as income within the £500 exemption will still be taxable in the hands of beneficiaries.
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The exemption is on an all-or-nothing basis. A trust with an income of £501 will find the whole amount is taxable; not just the excess over £500. A further complication is that, in some circumstances, the £500 exemption is shared between trusts created by the same person.

When the £500 exemption was first proposed, it appeared relatively generous for savings income given the bank rate was 0.75%. However, it does not appear as beneficial now that the current bank rate sits at 5.25%.

Interest in possession (IIP) trusts
IIP trusts pay income tax at 20%, except for dividend income which is taxed at 8.75%. The £500 exemption will mean that smaller IIP trusts no longer have to file returns or pay tax, but this income will now be received gross by beneficiaries without any associated tax credit.

This is good news for non-tax paying beneficiaries as they will no longer need to make repayment claims. However, basic rate taxpayers will now have to account for tax on trust income, a liability previously met by the tax credit.

There will be no change for either the trust or the beneficiaries where trust income exceeds £500.

Discretionary trusts
Discretionary trusts pay tax at 45%, except for dividend income which is at 39.35% – the same rates paid by an additional rate individual taxpayer. Previously, there was a £1,000 standard rate band on which lower rates applied.

The £500 income exemption has replaced the standard rate band.

The complication for discretionary trusts is that any distributions to beneficiaries carry a 45% tax credit, even if the exemption applies. Therefore, the trust will still have to pay sufficient tax to cover the tax credit, which can mean complex calculations.

The beneficiaries of discretionary trusts will not see any change to their tax treatment given that trust income will continue to have a 45% tax credit attached.