Inheritance tax planning
Inheritance tax planning is no longer the exclusive domain of the very wealthy. The sustained increase in property prices has made it probable that many homeowners who may not have previously considered inheritance tax planning to be necessary, will now be subject to inheritance tax as a result of the rise in the value of their homes. Estate planning to reduce the total inheritance tax liability is becoming increasingly relevant and important.
There is currently a tax free allowance, known as the nil rate band, of £325,000 before inheritance tax becomes payable. The nil rate band has been frozen until April 2018, and thereafter the nil rate band will increase in line with the consumer price index. Above that threshold, inheritance tax is calculated at a rate of 40% on the net value of the estate passing on death.
Any unused percentage of an individual’s nil rate band can be transferred to their surviving spouse or civil partner. In this way, spouses and civil partners potentially have a combined tax free allowance of up to £650,000 at the time of the second death provided their nil rate bands have not been reduced by lifetime giving or gifts.
There are further exemptions and reliefs available on the transfer of certain assets that would otherwise be liable to inheritance tax depending on the type of asset, when it is transferred and to whom.
It is important to ensure that you not only have a valid will in place to control how your assets pass and prevent paying any unnecessary tax on death, but also to consider carefully how to utilise fully all the available exemptions and reliefs during lifetime and on death to maximise tax efficiency and reduce your overall inheritance tax liability.
The following types of gifts can be made without any inheritance tax consequences in lifetime and on death:
- Spouses/Civil partners – All gifts to spouses and civil partners are exempt from inheritance tax provided both are domiciled in the UK. Special rules apply when one or both are non-domiciled and not entitled to the full exemption.
- Charity – Outright gifts to charities, including charities in the EU, are exempt from inheritance tax. Additionally, if the amount given to charities on death exceeds 10 percent of the individual’s net estate, a reduced inheritance tax rate of 36% is applied to the remainder of the estate.
- Housing associations – Any gifts of land to housing associations or registered social landlords are free of inheritance tax.
- National purpose – There is no inheritance tax on gifts to galleries, museums, libraries and other bodies or institutions considered to be for national purposes.
Employee benefit trusts – Transfers of shares to employee benefit trusts are exempt from inheritance tax provided they meet certain conditions.
Other gifts can be made during lifetime without reducing your nil rate band or creating an immediate inheritance tax liability:
- Small gifts – It is possible to make gifts of up to £250 to as many people as you want so long as no one receives more than £250. If the gift exceeds £250 no part of the gift is exempt.
- Marriage/Civil partnership – On the occasion of marriage each parent may give £5,000, each grandparent or other relative £2,500, and all others £1,000 without attracting tax but there is no exemption if the marriage does not take place.
- Annual exemption – Gifts of up to £3,000 each year are entirely exempt from inheritance tax. It is possible to carry forward any unused portion of this exemption to the following year. Therefore if this exemption has not used in the previous year, a couple could give £12,000 with no inheritance tax consequences.
- Normal expenditure out of income – This is a particularly useful exemption as there is no upper limit to the value of this category of gifts provided the gifts do not affect the standard of living of the donor. This exemption is intended to be used where an individual earns more than they spend. The gifts should be out of excess income, be well documented and a pattern of gifts should be established. Giving in this way also prevents capital accumulating which would otherwise increase the inheritance tax liability on death.
Fully or partially relievable property:
In specific circumstances, during lifetime and on death, these asset classes attract favourable treatment for inheritance tax:
- Business property – Relief of either 50% or 100% depending on the type of business interest may be available. The main qualifying conditions are that there is a trading business and that the business interest has been owned for two years or more. This relief is not available in relation to businesses where the focus is on investment in stocks, property or holding other investments.
- Agricultural property – Relief is available on the agricultural value of the property and can be 50% or 100% depending on who owns and farms the land. To qualify for the relief, the property should essentially be a working farm run for commercial purposes.
- Heritage property – a conditional exemption is available for important heritage property so that inheritance tax is deferred on condition that access is allowed to the public and the claim is made is made within two years. In this way it is possible to pass heritage property between generations without an inheritance tax charge.
- Woodlands – Relief may be available to woodlands where Agricultural Property Relief and Business Property Relief do not apply. Woodlands relief is only available on death. The relief defers the tax charge until the timber is sold.
Immediately chargeable transfers:
Gifts into trust during lifetime are immediately chargeable to inheritance tax at 20% to the extent the amount transferred exceeds the individual’s nil rate band.
In the event that an individual dies within seven years of an immediately chargeable transfer, an additional liability will be triggered to increase the total inheritance tax liability on that transfer to a maximum of 40%.
Trusts are also part of the relevant property regime and may be subject to further ongoing inheritance tax charges. Nevertheless, trusts may be useful planning tools to reduce the value of your estate and pass assets between generations, but the rules are complicated and advice should be sought as to whether a trust structure would be advantageous in terms of the overall tax consequences.
Potentially exempt transfers:
Any other gifts to individuals made during lifetime are potentially exempt transfers (‘PETs’) and if the donor survives seven years from the date of the gift, the gift will not be taken into account when calculating the inheritance tax liability on death. These are considered ‘successful PETs’ and the value of the assets transferred will no longer form part of the individual’s estate for inheritance tax purposes.
If a PET is made and the individual dies within seven years of the date of that gift, the gift will become a ‘failed PET’ and will not be fully exempt for inheritance tax purposes. The value of the gift will reduce the nil rate band available and any amount by which the gift exceeds the nil rate band will be brought into account on death and taxed at a maximum of 40%. However, taper relief is available after the donor survives three years from the date of the gift and decreases the amount of tax on the gift proportionately to time that has elapsed since the gift.
Reservation of benefit and pre-owned asset rules:
When making lifetime gifts, it is important to ensure that you do not retain any benefit in the property given away otherwise the Gifts with Reservation of Benefit Rules will apply so that those assets are still considered to be part of your estate for the purposes of calculating inheritance tax on death. Alternatively the Pre-owned Asset Rules may apply so that there is an income tax liability.
Any future interest in a trust or interest in a trust created by a non-domiciled individual holding non-UK situs assets is ignored for inheritance tax purposes.
If you would like any further information or guidance, please contact:
T. 020 7227 7329
This briefing is for guidance purposes only. RadcliffesLeBrasseur accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.