I believe clients should have a basic understanding of the background law and concepts against which our advice is given. That is why I have written this quick guide to the basics of Inheritance Tax (IHT).
Of course, by the very nature of summarising this complex tax many important details have to be omitted and this note is not intended to be relied upon without you taking specific advice on your own position.
What is Inheritance tax
IHT is essentially a tax payable on the value of your estate when you die. However, it can also apply to gifts made during your lifetime e.g.:
- gifts to certain trusts;
- gifts to companies;
- gifts made within seven years of your death; and
- gifts where you have continued to enjoy what you have given away.
Ongoing IHT charges can also arise on assets that have been transferred into trust.
What is the rate of IHT
Every individual has a nil rate band (presently the first £325,000 of your estate) on which no IHT is payable. In addition, there are a number allowances, exemptions and reliefs available. At present IHT is charged at the following rates:
- 20% for chargeable lifetime gifts; and
- 40% on death on the value of your estate in excess of your nil rate band.
Certain trusts also attract a charge of 20% when assets are given to the trust. These trusts also suffer a ten-year anniversary charge of around 6% and a further charge when assets are given to the beneficiaries of the trust. Each type of trust is taxed differently and expert advice must always be sought. However, despite this, trusts should be an option you consider in your IHT tax planning.
Transferring the nil rate band
As many people leave substantially the whole of their estate to their surviving partner, the nil rate band of the first of any couple to die generally went unused. Use of Wills containing “nil rate band trusts” allowed many people to mitigate this. However, as a result of changes introduced in 2008 a surviving spouse or civil partner can now effectively “inherit” the unused percentage of their deceased spouse or partner’s nil rate band. If you have a Will that is drafted to set up a “nil rate band” trust on your death it might be prudent to have this reviewed.
There are a number of exemptions available, some of which apply only to gifts made during your lifetime but others which apply both to lifetime gifts and gifts on death made under your Will. Of these, the key exemptions are:
- Gifts to your spouse or civil partner; and
- Gifts to charities.
Perhaps not unsurprisingly gifts to certain UK political parties are also exempt!
Potentially exempt transfers
If you make a gift during your life to another individual (which does not fall into one of the exemptions available) this may become liable to IHT on death if you do not survive the gift by at least 7 years. These gifts are known as potentially exempt transfers (PETs). The amount of tax that is paid depends on how long you survive from the death. This starts with the gift being fully taxable (at 40%) if you die within 3 years of the gift and then tapering down (taper relief) by fifth each year to 0% if you survive the gift by more than seven years.
Business Property Relief
For most of our clients the most significant IHT relief is business property relief (BPR) which applies to certain business assets. BPR can result in 100% relief (ie no IHT payable) on shares in private companies and other interests in a business (e.g. sole traders or partnerships), and 50% relief for assets, such as land and buildings, used by your partnership or company.
However, relief is not available if the business or company’s activities consist mainly in dealing in securities, stocks or shares, land or buildings, or making or holding investments. Careful tax planning may be necessary, particuarly if you hold shares in a group which comprises both trading companies and investments companies to ensure that the investment assets do not taint the availability of BPR.
If you sell your business, you should of course review your IHT tax planning strategy as you will likely have taken an asset (say, shares) that were exempt from IHT into cash which will be fully chargeable.
Gifts with reservation of benefit
Giving away assets during your lifetime can be a part of your IHT mitigation strategy. However, for a lifetime gift to be effective for IHT purposes not only must you survive the gift by 7 years, you must give the property away without any strings attached. If you continue to enjoy the property given away, it can remain part of your estate for the purposes of calculating IHT. These gifts are called gifts with reservation of benefit.
These reservation of benefit provisions are part of the anti-avoidance strategy aimed at artificial transactions designed to exploit tax loopholes. Unfortunately, they can can also catch the unwary. At any one time there are a number of mitigation schemes being marketed by various organisations and I would always advise clients to think carefully about these schemes and discuss them with their professional advisors before signing up for them. Quite often such schemes:
- may be more risky than the client had realised;
- perhaps not as specialised as the salemen may make out; and
- perhaps not as expensive if you engage a solicitor to deal with it for you.
I reguarly advise clients on their IHT planning and Wills. Contact us, find out how we can help you: