Death duties have been with us for centuries – once called Estate Duty, then Capital Transfer Tax and now Inheritance Tax (IHT).
Irrespective of the name, the purpose has always been the same – to raise revenue from estates.
IHT now no longer only affects the wealthy – with house prices showing a dramatic rise in the last few years, many more people will now be drawn into the ‘net’.
An Estate can include the family home or a share of it, all your bank accounts, building society accounts, your investments including Income Tax and Capital Gains Tax free products such as ISA’s and life policies not written into trust, jewellery, furniture, pictures, your time share in Tenerife, your car… i.e. with a few exceptions, all of your assets, wherever situated.
For IHT purposes the value of your Estate also includes all of your assets and the value of any gifts made within 7 years of death (subject to the exemptions listed below).
The Nil Rate Band
Thankfully there are some exemptions for IHT, the most important one being the ‘Nil Rate Band’.
The current Nil Rate Bank is £325,000.00
The entire Estate in excess of the Nil Rate Band is taxed at 40%.
Each individual has their own Nil Rate Band to use, regardless of whether they are married, divorced, unmarried or a civil partner.
There are many ways to reduce the IHT payable on an Estate and some of these are listed below.
Transfers between spouses and civil partners - No IHT is payable on assets passing during lifetime or on death from one spouse (or civil partner) to another – there is no limit to this exemption.
This exemption is not available to unmarried couples, no matter how long they have lived together or if they have children together (n.b. it is worth noting that the law does not recognise the term ‘common law marriage’).
Annual exemption and small gifts – Each individual can give gifts of up to £3,000 each tax year, exempt from IHT. If you have not used your exemption from the previous year then this can be carried forward for use in the next year, giving an allowance of £6,000 that year. Any unused allowance can be carried forward for use in one subsequent year only.
You can give an unlimited number of gifts up to £250 exempt from IHT, however the gifts must be given to different people in order to be exempt.
Normal expenditure out of income – Regular gifts made from income (not from capital) are exempt from IHT.
To qualify for this exemption the gifts can be any size, but they must not affect the donor’s standard of living and they must constitute a regular pattern of spending, however the gift does not have to be to the same person. If using surplus income in this way it is very important to keep careful records of the gifts as these will be examined very closely when IHT paperwork is submitted.
Gifts for the Maintenance of a Dependant – A gift of capital to maintain a dependant is exempt from IHT providing that the gift is for the maintenance of: a spouse, civil partner or former spouse or civil partner, a dependant child under 18 or over 18 and in full time education, or for a dependant relative who is disabled or infirm.
Gifts in Consideration of Marriage – Gifts can given free of IHT to the parties of a marriage or civil partnership, which can be a very useful exemption from IHT and a massive help given the astronomical cost of many weddings! Parents of the bride or groom can each give £5,000, grandparents can each give £2,500 and anyone else may give £1,000.
Gifts to recognised charities and other bodies – Gifts of any amount to charities, political parties or gifts for the public benefit e.g. universities, national museums, the National Trust etc. are also exempt. This can be a great way to help your favourite charity and if you feel that you cannot afford a lump sum during your lifetime, leaving a charitable gift in your Will is a wonderful opportunity to help.
Potentially Exempt Transfers (PETS)
Most other outright gifts to individuals fall into this category. No tax will be payable when the gift is made since it is treated as exempt and remains so provided the donor survives at least seven years following the date of the gift.
If death occurs within seven years of the gift then the value of the gift will be included in your Estate when IHT is calculated. Where the gift is less than the Nil Rate Band it will reduce the available Nil Rate Band on death, or where it exceeds the Nil Rate Band then any IHT due will be paid by the person who received the gift. Any increase in value from the date of the gift will be free from IHT.
Gifts made within three and seven years of death which exceed the Nil Rate Band will benefit from ‘taper relief’ which will reduce the amount of tax payable.
There are many reliefs available, far too many to include in this brief introduction to IHT. However two very important reliefs worth noting are Business Property Relief and Agricultural Property Relief, where, if the assets comply with certain rules 100% relief can be obtained.
Chargeable Lifetime Transfers
These are gifts that do not qualify as being exempt or potentially exempt, the most common example of which is a gift into a discretionary trust.
These gifts are only chargeable where the value of the transfer, when added to other chargeable lifetime transfers and any other available exemptions, exceeds the Nil Rate Band. Although chargeable, tax will only become due at a rate of 20% rather than 40%.
Nil Rate Band Discretionary Trust Wills
Prior to the changes made in the Pre-Budget Report 2007, Nil Rate Band Discretionary Trust Wills were an effective way of ensuring that married couples and civil partners were both able to fully utilise their individual Nil Rate Bands.
Changes made in the Pre-Budget Report mean that these complex Wills are now no longer necessary as a means of avoiding IHT. However, there are circumstances where these Wills are still very valuable, for example where there are reasons why the first spouse may not wish the survivor to inherit the entire of the estate outright, but wishes them to have access to the assets if they should require it. This can be useful in step-family situations or as a means of mitigating liability to care home fees.
If you would like to know more about Nil Rate Band Discretionary Trust Wills then we can meet with you to discuss whether, in view of your particular circumstances, these types of Will would meet your needs.
Transferable Nil Rate Band
In the 1997 Pre-Budget Report the Chancellor announced changes to the IHT regime that mean for married couples and civil partners, when the first spouse dies any unused Nil Rate Band can be transferred to the surviving spouse on their death.
The transfer of the Nil Rate Band only applies on the second death; however it is very important to keep accurate records relating to the estate of the first spouse and to store these records safely as they will be used to determine the amount of Nil Rate Band available to be transferred on the second death.
Where the estate of the second spouse to die is below the Nil Rate Band then there is no need to make an application to transfer the first spouse’s remaining Nil Rate Band, as there would be no IHT to pay anyway.
Where the estate of the second spouse is more than the Nil Rate Band there would usually be tax to pay of 40% on anything over and above the Nil Rate Band, however it is now possible to transfer any unused Nil Rate Band from the first spouse to die.
So, where there is an IHT liability on the death of the second spouse or civil partner to die, and there are clear records showing unused Nil Rate Band from the death of the first spouse or civil partner then by transferring the unused Nil Rate Band massive IHT savings are possible.
We can assist in dealing with the probate in relation to any estate, but particularly where there is the possibility of later transferring any unused Nil Rate Band we can ensure that the records kept are sufficient.
On the death of the surviving spouse we can assist in the probate of the estate and in making an application for the transfer of the first spouse’s unused Nil Rate Band.
A Few Final Points:
Capital Gains Tax – There is no Capital Gains Tax (CGT) to pay on death, the value of assets being taken as the actual value at death, known as the ‘probate value’.
However, a gift made in your lifetime is a disposal for CGT purposes and therefore may give rise to a CGT charge. Therefore full consideration must be given to CGT when making gifts to try to save IHT.
Life Assurance Policies – Check to see whether any of your life assurance policies or death benefits from pension policies can be out into trust as this way they won’t be classed as part of your estate for IHT purposes.
Pre-owned asset tax – The Finance Act 2004 introduced a new income tax charge, called pre-owned assets tax (POAT) which broadly applies to the continued use of previously owned assets. This new tax is based on the value of the asset or in the case of property on its rental value where this is in excess of £5000.
The Inland Revenue are encouraging taxpayers to unscramble certain arrangements by opting for the assets to be brought back into charge for the purposes of IHT.
It will be necessary to consider each case to see if it would be better to unscramble any arrangements by making the relevant election by 31st January 2007 or to leave matters as they are and to accept the rental and pay the Income Tax.
Gift with Reservation of Benefit – Where a gift is given away, but the donor continues to receive a benefit from that gift then this is classed as a Gift with Reservation of Benefit (GROB). If a gift is classed as a GROB it will be deemed that there was no real gift and the value of that item will be included in your estate for IHT purposes. For example – if parents give their home to the children but continue to live there rent free.
This is a summary of the Inheritance Issues that affect many people. Inheritance Tax is a complex area of taxation and if you require further advice or assistance please contact one of our team.