Inheritance Tax Planning

29 May 2015

Inheritance Tax planning is something that contractors usually put on their “to do later” list as it isn’t considered immediately pressing – however it can have massive implications for individuals and families in the untimely event of a death. Historically, many people would not be caught by IHT but because of rising property prices it is becoming increasingly common.

What is Inheritance Tax?

Inheritance Tax (IHT) is paid at 40% on a person’s estate (their property and possessions) when they die. IHT can also be charged on certain lifetime gifts, transfers in/out of trusts and transfers made by close companies (a company privately owned by less than five people).

What allowances are available?

There is a £325,000 lifetime allowance available to every individual (called the Nil Rate Band) so 40% tax is only chargeable above this level, however if 10% or more of the estate is left to charity then the rate is reduced to 36%.

Every individual also gets a £3,000 yearly allowance which can be carried forward from the previous year to a maximum of £6,000.

Tax Planning

Gifts & The Seven Year Rule

A gift can be defined as:

  • Anything that has a value (money, property, possessions)
  • A loss on value when something is transferred. If a parent sells a house to a child for less than it is actually worth, the difference in value is called a gift.

There are certain gifts that are IHT free such as wedding/civil partnership gifts (£5,000 for a child, £2,500 for grandchild or £1,000 for anyone) and gifts worth up to £200.

As you advance in age thought should be given to gifts. There is something called the seven year rule which means that if the original owner of the gift has given away more than £325,000 and they live for at least seven years, the person receiving the gift may have to pay IHT on it. In the event that the original owner dies between 3 and 7 years after giving the gift then the amount of IHT due will be reduced on a sliding scale.

Inter Spouse Exemption

There is an inter-spouse exemption where no IHT payable on any gift that married couples or civil partners give each other as long as they live in the UK permanently. If the estate is only left in part to non-spouses, then the segment that exceeds the Nil Rate Band (£325,000) is liable to 40%. Where the estate is left entirely to the spouse then the inter-spouse exemption will apply so no IHT is payable – however this increases the value of the surviving spouse’s estate and just defers the IHT issue to them.

Married couples should think whether the first spouse who dies leaves their entire estate to their spouse, or only part of it to the spouse and part to other family members such as children or in a trust. This means that you could utilise the nil rate band and leave £325,000 of the estate to children without paying IHT, with the balance going to the surviving spouse and being exempt from IHT under the inter spouse exemption.

Business Property Relief

Business property relief (BPR) provides 100% relief from IHT for a qualifying interest in a business, whether this constitutes a sole trade, a share in a partnership, assets used in a qualifying business or shares in a qualifying company. In order to qualify, the business or company must be carrying on a qualifying trade. While most trading activities will qualify there are a few excluded activities, such as dealing in securities and shares, dealing in land and property, or making or holding investments. Property development is, however, a qualifying activity. All owners of a business can qualify, whether they are involved in the running of the business or are just an investor.

Where there is a qualifying interest within the estate then it would be logical not to leave this to the surviving spouse – there is already an inter spouse exemption so the 100% IHT relief would be wasted.

Children from other marriages

Spouses who want to protect children from a former marriage, should consider leaving a suitable amount in trust. This will then allow the current spouse to enjoy the income arising from the trust assets during lifetime and for the children to take possession of the trust assets outright upon death.

What happens if I’m not married?

For unmarried couples or those not in a civil partnership, there is no inter spouse exemption and IHT must be paid at 40% above the Nil Rate Band of £325,000 upon death. It may be time to think about tying the knot sooner rather than later!

Do you need more information about inheritance tax?

Follow this link to contact the team at Source Accounting to find out more