Inheritance Tax Update

Our last article about Inheritance Tax (IHT) was prompted by the Office for Tax Simplification seeking views and perceptions of Inheritance Tax. The review and subsequent recommendations were far-reaching and can be read in full here, but we thought it would be useful to provide a summary just in case you are for some reason not keen to read an 82-page report about tax minutiae.

One of the most significant recommendations in the report was shortening the so-called ‘seven-year rule’. This rule essentially means that currently any gifts you pass on to before you die are exempt from IHT. The amount of tax payable then increases each of the seven years to 40% if the gift was given in the three years before death. The proposal put forward by the OTS is to decrease the number of years from seven to five, and scrap this ‘tapered’ system of collecting tax. Whilst this would decrease confusion amongst tax-payers, it also creates a ‘cliff-edge’ situation, whereby if the gift was given five years and one day before death, it would be tax free, but if it was given four years and 364 days, it would be subject to full IHT.

The OTS also advocates scrapping a quirk known as the “14-year rule” that affects those who have used trusts.

Another important recommendation involves changes to the ‘Single Gift Allowance’. Each tax year, you can give away £3,000 worth of gifts tax free. This is known as your ‘annual exemption’. You can also give away wedding or civil partnership gifts up to £1,000 per person (£2,500 for a grandchild and £5,000 for a child). These gifting scenarios are generally quite confusing, and furthermore, the sums involved have not changed since the 1980s, meaning that comparatively in today’s terms the annual limit would be £11,900 if accounting for inflation.

Another proposed change is to the so-called ‘normal expenditure out of income’ exemption, whereby you can currently give away unlimited amounts tax-free as long as this is done on a regular basis and “does not affect the giver’s standard of living”. This is problematic as there are no fixed definitions of ‘normal expenditure’ or ‘expenditure out of income’ and as a result the OTS has recommended introducing a fixed percentage of income that people are allowed to gift.

While only around 5% of estates actually have to pay IHT, you may still find yourself having to fill out a number of forms to comply with HMRC. If you would like advice on whether you have to pay inheritance tax or how to go about this, please contact us for more information.