Topic

The Taxation of Beneficiaries

During the administration period beneficiaries have no right to assets or income derived from them. Consequently, beneficiaries are only liable for income tax in relation to distributions that they receive.  

General (Pecuniary) Legatees 

Subject to the terms of the Will, general or pecuniary legatees are only entitled to interest where their legacy is paid more than a year after the testator’s death. This period is known as the Executor’s year.  The Executor’s Year is an accepted time frame (12 months from the date of death) to allow executors and administrators time to gather information together and check for potential claims and debts before the estate is shared amongst beneficiaries. The personal representatives must pay the interest gross if the legatee lives in the UK and net if tax if the legatee lives abroad. 

Specific Legatees 

Income from an asset specifically bequeathed is due to the specific legatee. The personal representatives should pay the income tax and provide the specific legatee with a tax deduction certificate.  

Residuary Beneficiaries 

While the estate is in administration, a beneficiary is only treated as receiving income if a distribution is made. Distributions include a transfer of assets, appropriation or the release of a debt. (Sections 649 to 682 of the 2005 Act contain the rules which determine what is to be treated as part of a beneficiary’s taxable income. Section 691 of the 2005 Act gives a wide definition of what a “payment” is).   

Therefore, if a distribution or appropriation is made, it is treated as a payment of an amount equal to the value of the asset at the date of transfer or appropriation. 

Beneficiaries are chargeable to income tax on the income that arises from their share of estate income. For UK estates, the ‘estate income’ is arrived at by grossing up the income at the appropriate tax rates. 

The formula for grossing up is: 

Net Amount   x 100            =             Gross Amount 

100 – Rate of Tax 

The rate of tax is the rate applicable to the year in which the distributions are made, NOT the rates applicable in the year(s) that the income was received by the personal representatives. 

Absolute Interests in Residue 

Section 650(1) of the 2005 Act specifies that this is where a beneficiary is entitled to capital of the residuary estate or would be once the administration of the estate is concluded.

A beneficiary with an absolute right to a share of the estate has an ‘assumed income entitlement’ during the course of the administration period. An assumed income entitlement is defined in Section 665 of the 2005 Act. In the final tax year of the administration of the estate any undistributed income is deemed to be distributed at the end of the administration period.   

EXAMPLE ONE 

B is entitled to the whole of the residuary estate of A. In 2019 the executors received bank interest which after the payment of tax the net sum was £1,000. B therefore has an assumed income entitlement of that income. 

However, although the beneficiary has an assumed entitlement, during the administration the beneficiary is only taxed on receipt of assets. The receipt may appear to be of a capital item, but if there is previously undistributed income, it will first be treated as income up to the amount of undistributed income for the administration period up to the date of distribution. If the value of the asset exceeds undistributed income then the excess will be capital. 

EXAMPLE TWO 

In 2018/19 the executors of Arthur Brown’s estate received bank interest which after the deduction of income tax amounted to £500. 

In 2019/20 the executors received further bank interest which after the payment of tax amounted to £400. 

On 5 April 2020 the executors appropriate Arthur’s motor car (value £12,000) to his residuary beneficiary Fred, this is the first distribution they make during the ongoing administration period. 

2018/19 income = £500 x 100 / 80  = £ 625 gross

2019/20 income = £400 x 100 / 80  = £500 gross 

Total undistributed gross income to date of distribution = £1,125 

Apportioned: 

Income distribution £1,125 

Capital distribution £10,875 

Fred receives a tax deduction certificate R185 for the tax year 2019/20 showing 

Net Amount – £900

Tax Credit – £225

Gross Taxable Amount – £1,125