Inheritance Tax TAX GUIDES. Alliotts, Chartered Accountants & Business Advisors.

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1 TAX GUIDES Inheritance Tax Alliotts, Chartered Accountants & Business Advisors Imperial House, Kingsway, London, WC2B 6UN T: +44 (0) F: +44 (0) E: Friary Court, High Street, Guildford, Surrey, GU1 3DL T: +44 (0) F: +44 (0) E: A Worldwide Alliance of Independent

2 INHERITANCE TAX Inheritance tax (IHT) can affect not only wealthy individuals but also UK homeowners with modest savings. It is, however, still possible to ensure that your estate passes to your family with minimal IHT liabilities. IHT is a tax on an individual s estate on death and on certain gifts made during their lifetime. When an individual dies, IHT is charged at 40% on the value of an individual s estate which exceeds their available nil rate band ( 325,000 in the tax year 2015/16 and frozen until at least April 2021). Any gifts made within seven years of death will reduce the nil rate band available on death. The transferable nil rate band Since 8 October 2007, the estate of a spouse/civil partner is able to benefit from the deceased spouse/civil partner s unused IHT nil rate band, regardless of when the first death occurred. The amount of the nil rate band available for transfer is based on the proportion of the nil rate band that was unused when the first spouse/civil partner died. The unused proportion will be applied to the amount of the nil rate band in force at the date when the surviving spouse/civil partner dies. Example David dies today leaving his children 108,333 (i.e. one-third of the current nil rate band) and the rest of his estate to his wife, Jane. On Jane s subsequent death, her nil rate band will be increased by two-thirds (which is the remainder of David s IHT allowance). So, if the nil rate band at the time of Jane s death is 360,000, she will be able to leave 600,000 free of IHT, i.e. 360,000 plus 240,000 (which is two-thirds of David s remaining IHT allowance). The nil rate band of the survivor can be increased by a maximum of 100%. Taper relief Taper relief ensures a reduced rate of IHT is payable if any gifts were made more than three years, but less than seven years, before death. There is also a 20% lifetime rate of IHT payable on gifts made to a discretionary trust whose value plus any other chargeable gifts made in the previous seven years exceeds the nil rate band. For deaths after 5 April 2012, the rate of IHT on the estate is reduced to 36% if at least 10% of the taxable estate is left to charity. Main residence nil rate band From 2017/18 an additional nil rate band, initially of 100,000 will be introduced to set against the value of your home provided it is bequeathed to a direct descendant. The band will be increased by 25,000 a year until 2020/21, when it reaches 175,000. Like the existing nil rate band, any unused portion will be transferable between spouses and civil partners, but unlike the existing band it will be subject to a 50% taper if your estate is worth more than 2,000,000. There will be special rules to deal with downsizing or selling up completely (e.g. on moving into a care home). All Rights Reserved Page 1 of 4

3 The main residence nil rate band in practice Jack and Jill each had an estate of 1.2m when Jack died in June His will left everything to Jill, who died of a broken heart eight months later. Thus Jill inherited 100% of Jack s nil rate band and, as his estate was under 2m, 100% of his main residence nil rate band (of 175,000). However, on Jill s death her estate was worth 2.4m, which brought the tapering rule came into play. Instead of having a total main residence of allowance of 350,000 (2 x 175,000), the allowance available to her estate was therefore reduced by 200,000 ( 400,000/2) to just 150,000. If Jack had used his 325,000 nil rate band on first death to make gifts to beneficiaries other than Jill, there would still have been no IHT on his death, but Jill s estate would have correspondingly smaller on second death. As a result, the available main residence allowance would have been 312,500 ( 350,000-75,000/2). Potentially exempt transfers Gifts to individuals or to a bare trust are called potentially exempt transfers (PETs) and will be outside of the estate after seven years. Making lifetime gifts can be an effective way to avoid IHT. Exemptions Some gifts are always exempt from IHT. Transfers between spouses/civil partners. Gifts up to the value of 3,000 a tax year (the exemption can be carried forward for one year). Any number of small gifts of up to 250 to each donee in a tax year. Regular gifts from income, provided they do not reduce the person s usual standard of living. Wedding gifts up to a limit determined by the relationship between the donor and the bride or groom (no more than 5,000). Gifts and bequests to UK charities, political parties and for the public benefit. Business and farming assets Interests in businesses and agricultural property may benefit from some extremely valuable reliefs, although they are subject to several conditions. In particular, you generally need to have held the assets for at least two years before they qualify for these special reliefs. The reliefs reduce the taxable value of the transfer by 100% or 50%. 100% IHT relief is given for: Shares in an unlisted trading company, or a trading company listed on AIM (the Alternative Investment Market) or the over the counter market PLUS. The business of a sole trader or an interest in a partnership. Owner-occupied farms and tenanted farms where the lease started after 31 August All Rights Reserved Page 2 of 4

4 50% IHT relief is given for: Assets owned by an individual and used by a trading company under their control, or by a partnership in which the individual is a partner. Tenanted farmland where the lease started before 1 September Gifts with reservation If you make a gift from your estate and still retain an interest or benefit in it, it is called a gift with reservation and it makes the gift ineffective from an IHT perspective. Pre-owned assets tax A gift that does not fall within the gifts with reservation rules may give rise to a special annual income tax charge where the donor continues to enjoy a benefit from a previously owned asset. This tax was introduced mainly to counter schemes to avoid IHT on the family home but can sometimes catch other arrangements. Trusts Trusts are helpful devices that are widely used in estate planning. They allow you to transfer money, property or other assets outside your estate into the legal ownership and control of other people you appoint (called trustees). These trustees are responsible for looking after the trust property for the beneficiaries. The beneficiaries could be children who are too young to hold property directly, or they might be disabled and incapable of looking after their own affairs, or they might be a group of people with different interests under the trust for example, some receiving the income and some the eventual capital. In many cases, trusts are set up to provide a degree of flexibility about how they will benefit. Life assurance policies are very often placed in trust so that the death benefits are paid directly to the beneficiaries and do not fall back into the insured person s taxable estate. Gifts into absolute trusts, trusts for disabled people and certain trusts for children where they become absolutely entitled to the trust property at age 18 qualify for treatment as potentially exempt transfers. But gifts into most other types of trust, particularly where there is an element of flexibility about who will benefit and when, are subject to the IHT regime that applies to discretionary trusts. To the extent that they exceed the value of the nil-rate band ( 325,000 in 2013/14), the charges are: 20% on the initial transfer into the trust. A periodic charge of 6% every ten years. An exit charge which is a proportion of the ten-yearly charge, depending on when the assets leave the trust. For example, if there have been no other transfers to take into account, the initial charge on a lifetime gift into trust of 405,000 would be 20% of 100,000 (i.e. 425,000 less 325,000). The net gift is 'grossed up' for IHT purposes, i.e. the net 405,000 gift into the trust is 425,000 less 20,000 tax. The periodic charge after ten years would be 6% of say 200,000 if that were the difference in the value of the assets in the trust and the nil rate band at the time (i.e. 12,000), and on the same basis, on a transfer out after two more years at the same amount, the exit charge would be 2,400. All Rights Reserved Page 3 of 4

5 IHT planning The earlier IHT planning starts, the more likely it is to reduce the eventual tax bill. Many IHT planning strategies involve making gifts. Before you do so, you should ensure that you have enough income and capital for your own needs for the rest of your life. Some other issues to consider are: Making an up-to-date, tax-efficient will. Giving away assets that you will not need. Making use of annual exemptions. Using your deceased spouse's/civil partner's nil rate band, if available. Paying into a pension plan. Having a comfortable retirement means that you may be able to give away some investments, and pension death benefits are also generally IHT-free. Equity release can reduce IHT and boost income in retirement. Consider establishing a lump-sum IHT plan that allows you to make a gift into a trust, while still retaining an income. Capital gains tax may be payable if you gift an asset that has a gain. Do not forget about the possible impact of other taxes. You may have to pay capital gains tax if you give away an asset that you bought for much less than its present value. How we can help It is important that your will and any other estate planning reflect the realities of your tax and financial position. We can work with your legal advisers on the best way to structure your estate. If you do not have trusted and expert legal advisers who are specialists in estate planning, we can introduce you to competent specialist advisers. We can construct an effective tax and investment planning strategy that will integrate with the overall financial planning for your family as well as your business and investment interests. This guide is for general information only and is not intended to be advice to any specific person. You are recommended to seek competent professional advice before taking or refraining from taking any action on the basis of the contents of this publication. This publication represents our understanding of law and HM Revenue & Customs practice as at January All Rights Reserved Page 4 of 4

6 Thank you for your interest in this Essential Guide. For further information or if you would like to discuss any aspect of the guide, please contact us. Alliotts Imperial House Kingsway London, WC2B 6UN Tel: Fax: Alliotts are registered to carry on audit work in the UK and regulated for a range of investment business activities; and licensed to carry out the reserved legal activity of non-contentious probate in England and Wales by the Institute of Chartered Accountants in England and Wales. All Rights Reserved