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10 Facts about Inheritance Tax that you may not be aware of

Tax Inheritance

Did you know…

  1. That despite its name not all inheritance tax is paid on death?

Chargeable lifetime transfers by individuals into most types of trust could potentially give rise to an IHT liability at the lifetime rate of 20%.

  1. That in the tragic event of two (or more) persons dying simultaneously, or in circumstances where it is not possible to determine who died first, then for legal purposes, including IHT, the older person is deemed to have died first (then the next oldest and so on)?

When writing a Will or considering some IHT planning it is worth bearing this in mind.

  1. That a person’s chargeability to IHT is determined by his domicile (broadly equivalent to nationality) and not by residence or other factors?

Consider the case of Donna, a single lady with a UK-domicile living in Australia, owning property in both Australia and New Zealand. On her death Donna’s estate will be chargeable to UK IHT because of her UK domicile.

  1. That the spouse exemption is limited where one party to the marriage is non-UK domiciled?

The general exemption for transfers to a spouse usually operates without limit. A vast estate passing from one spouse to another will   normally be totally free of an IHT charge. But with a non-Dom spouse the exemption is limited to the amount of the nil rate band-currently £325,000. However the non-Dom spouse can elect to “opt in” and be treated as UK domiciled for IHT purposes.

  1. That the residence nil rate band of £175,000 is abated if the value of the gross estate exceeds £2 million.

The abatement is at the rate of £1 for every £2 by which the estate value exceeds this threshold. It is important to remember that in valuing the gross estate assets which are normally exempt from IHT have to be included. If the total estate exceeds £2,350,000 then there will be no abated relief.

  1. That gifts out of surplus income are immediately exempt from IHT without having to worry about any claims, annual exemptions, returns or seven-year delays.

True there are some conditions:

  • Gifts are part of the normal, habitual or typical expenditure of the transferor.
  • Taking one year with another, they are made out of income (i.e. not out of capital).
  • The transferor is left with sufficient net income to maintain his or her usual standard of living.

This is a very valuable exemption and is often overlooked. It is particularly helpful to widows and widowers enjoying relatively substantial incomes part of which would otherwise be added to capital and one day charged to IHT.

  1. That you can pass a property, or an interest in a property, or other assets to a family member without incurring any capital gains tax or IHT charges?

It’s actually quite easy. Suppose you have a small cottage in the Lake District currently valued at £300,000. You bought it years ago for £175,000 and you want to pass it on to your daughter Delia. You set up a trust and transfer the property into trust, at the same time electing to hold over the gain. The trusts sits there with the property in it and its value for CGT purposes is the original cost of £175,000. A little later the trustees transfer the property to one of the beneficiaries (Delia of course) and again the trustees hold over the gain. Delia now owns the cottage and the trust is wound up! No tax has been paid although the downside is that Delia’s original cost for CGT purposes is still £175,000. Who knows? When Delia comes to dispose of the property she may set up a trust as well!

  1. That although 100% business property relief (BPR) is available for most business assets (including shares in any unquoted company) there is an issue when it comes to directors’ loan accounts?

Most company directors of family-run businesses will have a loan account with the company. This is the director’s piggybank and houses all his spare cash, extra dividends, bonuses and the like. The money is available for the company to use for business purposes but HMRC says that the balance in a DLA is not covered by BPR. Directors with substantial BPR balances should consider moving part of them at least to other forms of securities with the company where BPR is fully allowable.

  1. That the use of pension funds can be a very effective means of avoiding IHT charges.

Pension savings are typically held in trust outside one’s estate and are thus free from IHT in most cases. This is because the pension scheme administrator normally has discretion over who inherits a pension pot. Typically he will be guided by a letter of wishes. Because such letters or forms are not usually legally binding the pension pot will not form part of an estate for IHT purposes.

  1. That a Will can be varied after the testator’s death provided all affected beneficiaries are in agreement. Invariably the reason for a Deed of Variation is to reduce the impact of IHT but this is quite acceptable provided all conditions are met.

To be effective for tax purposes a Variation must be made within two years of death. Such deeds are treated as if they had been made by the testator. They can be very useful in correcting a drafting error in a Will. Another application would be the unfair omission of a family member from a Will which the rest of the family wish to correct.

C&H Stedman

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