Mitigating IHT (Inheritance Tax)
Making use of IHT reliefs and exemptions
IHT is principally a death duty and to a lesser extent a tax on lifetime gifts. Other than spending all your wealth before you die, IHT planning will be necessary to ensure that you leave as much as you wish to your loved ones.
Who is affected?
Those individuals who are UK domiciled are chargeable to IHT on their worldwide property and non-UK domiciled individuals are chargeable in respect of property in the UK.
Upon the death of a person, the value of their estate, after various exemptions and reliefs, is liable to IHT. The executor of the will or the administrator of the estate will then pay the IHT using the funds from the estate. The tax has to be paid by the end of the six month after the person dies.
In general, the recipient of an inheritance doesn’t have to pay IHT although there are some exceptions.
Rate of tax
The first £325,000 (nil-rate band) of the estate is exempted, with the balance charged at 40%. The rate may be reduced to 36% if 10% or more of the estate is left to charity .
In addition to a person’s own nil-rate band it is possible to utilise any proportion of a spouses or civil partner’s nil-rate band that was unused upon death. For example, if a wife leaves her whole estate to her husband on her death, on the husband’s death his estate would benefit from his own nil-rate band plus his wife’s, giving a total of £650K free from IHT. This applies even if that person remarries.
An estate may not have to pay IHT on assets that the deceased gave away as gifts while they were alive.
A gift can be anything that has a value, e.g money, property or possessions.
Gifts between married couples or civil partners are free from IHT provided they live in the UK permanently.
Potentially exempt transfers (PEs)
Gifts to individuals or to a trust for a disabled person where the donor lives for seven years after making the gift, is exempt from IHT. Where the donor dies before the seven years however, a potential IHT charge arises but as the gift falls within the nil-rate band, the tax charge could be nothing.
Gifts of £3,000 in a tax year are exempt. Any surplus allowance can be carried over from one tax year to the next but the maximum exemption is £6,000.
Regular use of this exemption say over a 10 year period would result in £30,000 free of IHT out of a chargeable estate or £60,000 for a married couple/civil partnership, saving tax of £12,000 and £24,000 respectively.
Small gifts exemption £250
There is no IHT on individual gifts worth up to £250. A person may give as many people as they like up to £250 in any one tax year. This is intended to cover the likes of birthday and Christmas presents. This cannot be used in conjunction with the £3,000 annual exemption. It is not possible therefore to give someone another £250 if the donor has already given them a gift using the £3,000 exemption.
Where a son or daughter or step-son/daughter gets married or enters into a civil partnership, a cash gift or gift in kind will be exempt depending on the relationship between the donor and donee.
Normal expenditure out of income
To qualify for this exemption gifts must be part of the donor’s normal expenditure. Taking one year with another, it must be made out of the donor’s income and must not reduce their available income (after they have paid tax) below that required to maintain their usual standard of living. Typically, this will often apply to life insurance premiums paid for the benefit of someone else.
Alice is both widowed and retired. She receives a number of pensions from former employers but does not need approximately 10% of her net annual income, i.e £9,000. She has one son, Roger, to whom she gifts the £9,000 surplus income.
No IHT is due on gifts to help with other people’s living costs if they are made to, for example:
• an ex-spouse or former civil partner
• a relative who’s dependant on them because of old age, illness or disability
• a child (including adopted and step-child) under 18 and in full-time education
Zak’s mother has become infirmed and needs to go into a care home, as she is no longer able to look after herself. Zak contributes towards the cost of the care home for his mother.
Business property relief (BPR)
Whilst there are a number of reliefs available that allow some assets to be passed on free of IHT or with a reduced bill, BPR is the main one of interest for contractors.
Any ownership of a business or share of a business is included in the estate for IHT purposes.
BPR reduces the value of a business or its assets when calculating the IHT liability and is given at either 100% or 50% on business assets depending on the nature of the business property involved.
• A business or interest in a business
• Shares in an unlisted company
• Shares controlling more than 50% of the voting rights in a listed company
• Land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled
• Land, buildings or machinery used in the business and held in a trust that it has the right to benefit from.
Relief can only be claimed where the deceased owned the business or asset for at least two years before they died.
BPR cannot be claimed if the company:
• mainly deals with securities, stocks or shares, land or buildings, or in making or holding investments
• is a not-for-profit organisation
• is being sold, unless the sale is to a company that will carry on the business and the estate will be paid mainly in shares of the company
• is being wound up, unless this is part of a process to allow the business of the company to carry on
BPR cannot be claimed on an asset if it:
• also qualifies for Agricultural Relief
• wasn’t used mainly for business in the two years before it was either passed on as a gift or as part of the will
• isn’t needed for future use in the business
Gift with reservation of benefit
Where someone passes on their home to their children or someone else and continues to live in it rent-free, the value of the home is included in their estate even if they have lived in it for seven years after giving it away. This is known as a gift with reservation of benefit.
However, this rule will not apply if the donor pays the new owner a ‘market rent’ (the going rate for similar local rental properties) for as long as they reside there.
Included amongst a number of other exemptions are gifts to charities and political parties.