Benjamin Franklin once said “There are only 2 certainties in life – death and taxes” – IHT is where these two certainties meet head on and can lead to staggering sums of money being paid over to the Exchequer.
Here we look at the IHT basics to recap on the main rules. In later bulletins we will consider some of the reliefs and exemptions in further detail.
So who pays IHT and on what is it paid on?
IHT is paid by UK domiciled (or deemed domiciled individuals) on their worldwide assets. Non UK domiciled individuals pay IHT on their UK situated assets.
It is generally paid on death but can also be payable during lifetime on gifts into Trust.
An individual is deemed to be UK domiciled if he or she has been resident in the UK for 15 out of the last 20 tax years.
We will cover here the rules applying on the death of an individual.
IHT on death
All the assets to which the deceased is beneficially entitled are aggregated at the date of death for inclusion in the estate, being valued at market value. This includes among other things:
- All property to which the deceased had a beneficial entitlement
- Bank and Building Society Accounts
- ISA’s
- Investments such as stocks and shares
- Beneficial Interest in any Interest in Possession Trust
- The value of any gifts made in the seven years prior to death
From the net estate value any reliefs are taken into account, for example:
- Business Property Relief
- Agricultural Property Relief
- Gifts to Charity
- Transfers to a Spouse – there is no similar exemption for unmarried couples
- The IHT Nil Rate Band
- Any Transferable Nil Rate Band (from a deceased spouse)
- Any Main Residence Additional Nil Rate Band
- Any transferable Main Residence Additional Nil Rate Band (from a deceased spouse)
The tax is normally payable six months after death.
So looking at a typical estate that may arise on the later survivor of a husband and wife:-
| £ | |
| Share of main residence (net of mortgage) | 800,000 |
| Other property (net of mortgage) | 400,000 |
| Jewellery / works of Art etc. | 20,000 |
| Vehicles | 30,000 |
| Investments – stocks and shares | 250,000 |
| ISA’s | 250,000 |
| Bank and Building Society Accounts | 250,000 |
| Total estate value | 2,000,000 |
| Nil Rate band | (325,000) |
| Transferable Nil Rate Band | (325,000) |
| Chargeable Estate | 1,350,000 |
| IHT @ 40% | £540,000 |
Take this opportunity to add up your own Personal Balance Sheet (total assets less total liabilities) to see the potential quantum of your IHT bill – you may be surprised at just how big the number is!
Are there many ways such a large tax bill can be mitigated?
Lifetime exemptions – the following gifts are exempt from IHT:
- Annual exemption - £3,000 per tax year (£6,000 the first time such gifts are made).
- Small gifts – gifts up to £250 per recipient can be given away per tax year
- Gifts in consideration of marriage up to certain limits
- Normal expenditure out of income – this is a valuable relief and not used as often as it should be. Provided the gift is out of income and not capital it is covered by this exemption. Regular giving of up to circa 25% of net income per tax year could qualify under this exemption – detailed records need to be kept to provide evidence that the expenditure is out of income and not affecting capital
There are a number of IHT planning steps that can be taken during your lifetime to mitigate the potential IHT:
- The first thing to consider is whether life assurance can be used to cover the potential liability – obviously the earlier this is put in place the cheaper it is. The policy must be written in trust otherwise the policy proceeds can form part of the estate and be taxed accordingly
- Lifetime gifts – these fall outside the IHT net after seven years from the date of the gift
- Take advantage of the exemptions set out above, especially the annul exemption and the “normal expenditure out of income” exemption
- Lifetime transfers into Trust – these are Chargeable lifetime transfers but provided the value transferred is within the Nil Rate Band no tax is payable. Such transfers have the advantage of being able to hold over any capital gain on the asset going into trust. The value of the transfer falls outside of the IHT net after seven years.
- Financial Products – there are a number of financial products that can assist with IHT planning including AIM portfolios; unquoted trading company structures; Discounted Gift Plans – we will be happy to talk these through with you
Roy Jenkins famously said “Inheritance Tax, is broadly speaking a voluntary levy paid by those who distrust their Heirs more than they dislike the Inland Revenue”. Whilst this is a slight exaggeration, there is certainly no need to pay more IHT than you absolutely have too and with the benefit of careful long term planning IHT can certainly be reduced or substantially mitigated.