On 27 April, the Office for Tax Simplification published a call for evidence to gather information about people’s experience and perceptions of Inheritance Tax. Whilst the results of this review are not guaranteed to impact government policy, we thought it might be useful to take a look at this controversial scheme as well as answering some frequently asked questions and clarifying some basic terminology.
What is inheritance tax (IHT)?
Inheritance tax is a 40% tax on estates valued higher than £325,000 (reduced to 36% if more than 10% of the estate is given to charity). If you are married or in a civil partnership, you can pass on your allowance to your partner effectively creating a £650,000 threshold. An additional ‘residence nil-rated’ band was introduced recently enabling a couple to pass on a home to descendants worth up to £1mn without paying inheritance tax.
Why is inheritance tax controversial?
There are many reasons that inheritance tax has been a controversial topic, even though less than 5% of estates are acutally subject to the tax. These range from the fact that the property/income that is subjected to the fairly significant 40% tax has usually already been taxed throughout a person’s life (so-called “double taxation”) to the fact that the wealthy, who the tax is supposed to target, can generally find ways to reduce or avoid the tax such as through trust structures or special share types that are exempt. The rules have also become so complicated, that most people are unable to navigate their complexities without professional assistance.
How can I save money on inheritance tax?
As mentioned above, you can transfer your entire estate to a spouse or civil partner tax free. They also inherit your IHT allowance. If you leave money to other family members, this amount is deducted from the £650,000 total.
Another easy way to save money is to gift assets to descendants before you die. If you survive more than 7 years after the gift, inheritance tax is not due. These lifetime transfers are known as Potentially Exempt Transfers (PETs) and if the taxpayer dies within 3 years of making the gift, then the inheritance tax position is as if the gift was made on death. In between 3 and 7 years, there are incremental amounts to be paid as per below.
The effective rates of tax on the excess over the nil rate band are:
- 0 to 3 years before death 40%
- 3 to 4 years before death 32%
- 4 to 5 years before death 24%
- 5 to 6 years before death 16%
- 6 to 7 years before death 8%
It is important to note that the situation here is more complicated if the person giving the gift does not fully give up control over the assets concerned. A common example is a person giving their house away but continuing to live in it rent-free. Such gifts are known as ‘gifts with a reservation of benefit’. These gifts can remain subject to inheritance tax even if the taxpayer dies more than 7 years later.
We would recommend that you keep a list of any PETs that you make. It is also important to keep a record of any exemptions that are used as well as details of any regular gifts made out of surplus income.
You can also give away £3,000 per year without it being subject to inheritance tax , a sum that aggregates year-on-year if you do not use all of it in a given year.
Business property relief (BPR) was originally introduced to allow companies to be passed down generations without having to be broken up in order to pay inheritance tax . Under specific circumstances, this can be used to avoid inheritance tax and it also gave rise to Aim investment funds, whereby BPR can be claimed on certain shares of companies listed on the Alternative Investment Market (Aim), if they have been held for more than two years.
Complex trust structures are also used to reduce a family’s tax bill, though these are expensive to run and would certainly require professional assistance to administer. There can also be a liability to inheritance tax if an inheritance you receive is put into a trust and the trust can’t or doesn’t pay.
Do I have to pay tax on things I inherit?
The answer to this question is generally no. This is because inheritance tax is usually levied on a person’s estate when they die and can also be payable during a person’s lifetime on certain trusts and gifts. If you are the heir to all or part of the deceased estate, you should not be liable to pay tax on the inheritance. Any inheritance tax due, will normally be paid out of the deceased’s estate before any cash or assets are distributed.
The beneficiaries are liable to income tax on any profit earned after the inheritance, such as dividends from shares and to capital gains tax on any increase in the value of assets that are sold after the date of inheritance.
If you would like any advice about inheritance tax, please get in touch to arrange a consultation.
If you would like to contribute any anecdotal evidence to the OTS review, please visit https://www.gov.uk/ots
Source: Schoolgate Accounting Services | 28-4-18