Inheritance Tax Planning

What is Inheritance Tax (IHT)?

Inheritance Tax is a tax which can be levied on death or even during someone's life on gifts made to non exempt beneficiaries. It is a reasonably harsh tax, applying to all of an estate which exceeds the nil rate band available at the date of death.

The old situatution for married couples

Prior to 9th October 2007, the way IHT was levied meant that in all cases where an individual died leaving an estate in excess of £325,000 to non exempt beneficiaries (ie, someone other than a spouse/civil partner or charity) their estate would bear IHT at a flat rate of 40%.

The new situation for married couples/those in a civil partnership

However, in the Pre-Budget report of 9th October 2007 the government announced changes to the law on IHT. These changes have been widely misinterpereted by the pres and it is wrong to say that the nil rate band has simply doubled to £650,000.

The changes in fact mean that if the first of a married couple/civil partnership dies leaving their estate outright to the surviving spouse/civil partner then their nil rate band (which previously would have been lost) is then available to aggregate with the nil rate band of the surviving spouse/civil partner. This will in many cases mean that the nil rate band is doubled on the first death. There are a few important points to bear in mind with this:

1. If any part of the nil rate band is used on the first death, then this will reduce the proportion of the nil rate band available to aggregate with the survivor's nil rate band on the second death.

2. The first deceased's nil rate band that is aggregated with the survivor's nil rate band is worked out by taking the percentage of the unused nil rate band and multiplying this by the nil rate band available at the second death. (Eg, Mr Jones dies in 2008 and leaves 100 percent of his estate to his wife Mrs Jones. Mrs Jones dies some years later and the nil rate band is then £400,000. The total amount available is £800,000)

3. Any unused nil rate band remaining after a first death cannot be used in conjunction with lifetime gifts - it can only be claimed on death.

The continuing situation for everyone else

The nil rate band for single and divorced individuals who have not remarried remains at £325,000. Any surplus is taxed at 40percent. Therefore, if an estate is worth less than £325,000 there will be no Inheritance Tax to pay.

When someone dies the Personal Representatives of the estate are obliged to investigate the size of the estate and if necessary submit an Inheritance Account to the Inland Revenue. They must take into account all lifetime gifts which have been made over the past 7 years preparing the Account.

PETs

This may sound like a reference to a cuddly household animal but it is not.

PET in Inheritance Tax terms stands for Potentially Exempt Transfer. If someone gives away property during their life to a non exempt beneficiary and the value of the transfer exceeds their annual allowance for Inheritance Tax (presently £3,000) then, subject to some other provisos, this gift will form a PET.

This means that the transfer will be chargeable to Inheritance Tax if the person making the gift dies within 7 years of having given the property away. If that person survives for more than 3 years and if that gift is in excess of the nil rate band, the part that is in excess of it will be subject to "tapering relief" on the charge to Inheritance Tax.

Gifts into Discretionary Trusts are never PETs.

Gifts with Reservation

This may occur where someone gives away property to try to reduce the size of their estate for Inheritance Tax purposes but carries on using the property.

This might happen where a parent gives part of their property to their son or daughter but remains in occupation at the property. In this case the property will be treated on death as though it still belonged to the parent.

Trusts Myth

It is a common misconception that Inheritance Tax can be avoided simply by placing property in trust.

Exempt beneficiaries

Certain people or institutions as beneficiaries do not give rise to Inheritance Tax. These would include a spouse or charity. Children are never exempt beneficiaries and it is often the second death between a husband and wife which gives rise to difficulties with Inheritance Tax.

Types of Joint ownership

There are 2 types in England and Wales:

a) Joint Tenants - If one co-owner of property such as a house, bank account or any other type of property dies, then their half share passes direct to the survivor regardless of the details contained in their Will

b) Tenants in Common - If one co-owner dies then their interest in the property is dealt with under the terms of their Will.

Reliefs

This is a complicated subject. It is possible to obtain various types of relief in certain circumstances against types of property. For example Business Property Relief may be available against some business assets on death reducing the Inheritance Tax bill.