INHERITANCE TAX

WHAT IS INHERITANCE TAX?

Inheritance tax is a tax that is payable at 40% on estates that have a value in excess of £325,000 (as at April 2012). So if an estate was worth say £425,000 then the first £325,000 would be tax free but the remaining £100,000 would be taxable at 40% and a tax bill of £40,000 would be payable.

INHERITANCE TAX STRATEGIES

In order to assess whether your estate might be subject to Inheritance Tax you must work out how much it is worth. This means calculating the value of your assets and deducting your debts to roughly assess the net value of your assets.

Even if you feel that the net total value of your assets are under the £325,000 (April 2012) Inheritance Tax Nil Rate Band threshold, it may be that the value of your estate will increase over the coming years and you could be liable to pay Inheritance Tax. Therefore if the net value of your estate is over the Nil Rate Band limit then you should start planning around Inheritance Tax sooner rather than later.

There are a number of strategies that you could use to reduce Inheritance Tax. Sadly this web page can only provide very basic information about Inheritance Tax and specifically how Inheritance Tax applies in relation to making a will. However if you have any questions about Inheritance tax then please call us for a free no obligation chat.

MAKE AN INHERITANCE TAX WILL

Whatever your financial circumstances are it is always important to make a will. Indeed if you are worried about paying Inheritance Tax there are provisions you can include in your will that will save you paying Inheritance Tax. For example, any legacies to Charities, Political Parties, National Museums and other similar organisations are exempt from Inheritance Tax. So if you had a net estate worth £400,000 and you left £75,000 to charities then the remaining £325,000 would be exempt under the Nil Rate Band and you would not have to pay any Inheritance Tax.

REDUCE THE VALUE OF YOUR ESTATE

One simply way of reducing or avoiding paying Inheritance Tax is to reduce the value of your estate. The less there is in the estate the less Inheritance Tax will be payable. However, giving away your assets after spending some considerable time building them up is probably not something you would willingly want to do to avoid Inheritance Tax. Sometimes however it is possible to dispose of some assets without negatively affecting your standard of living while you are still able to enjoy it for yourself. Any gifts made during your lifetime will be regarded as “Potentially Exempt Transfers” and if you die within seven years of making a gift then a proportion of that gift value might be taken into account when calculating the value of your estate for Inheritance Tax purposes – (see further below).

SPOUSE EXEMPTION

If a married couple with children wanted to leave the whole of their estate to each other, then they would find that there would not be any Inheritance Tax payable on the first death. This is by virtue of there being a “spouse exemption”. It is therefore on the second death when the assets are transferred to probably to the children and others that an Inheritance Tax bill can potentially arise.

INHERITANCE TAX NIL RATE BAND GIFTS

A common arrangement that was used to reduce or avoid paying Inheritance Tax was to make a special will and not to leave everything to the spouse but instead to set up a trust and leave a gift or a loan to say, the children or other beneficiaries, of a sum equivalent of up to the value of the Inheritance Tax Nil Rate Band (up to £325,000) and the balance of the estate to the spouse. With this arrangement there would be no Inheritance Tax bill because the first £325,000 is exempt under the Nil Rate Band and the balance would be Spouse Exempt. However, a balance needs to be struck between the amount to gift or loan to the children or other beneficiaries (to save Inheritance Tax) against the priority of making sure that the surviving spouse has enough assets and money to live on.

However since the introduction of the “Transfer of the Nil Rate Band” has resulted in the creation of special wills with Nil Rate Band gifts are no longer necessary and are less common.

TRANSFER OF NIL RATE BAND

The nil rate band – currently £325,000.00 per individual is now transferable. The estate of a surviving spouse or civil partner is able to benefit from any unused Inheritance Tax nil rate band of their deceased spouse or partner. This applied on the death of a surviving spouse or partner after 8 October 2007, 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 or partner died. The unused proportion will be applied to the amount of the nil rate band in force at the date of the surviving spouse or partner’s death.

For example, Mr A dies today leaving his children £108,333 (i.e. one third of the current nil rate band) with the rest of his estate passing to his wife. On Mrs A’s subsequent death, her nil rate band will then be increased by two thirds. So, if the nil rate band at the time of Mrs A’s death is £360,000, she will be able to leave £600,000 free of Inheritance Tax, i.e. £360,000 plus £240,000 (two thirds of £360,000).

If a person marries more than once, the nil rate band of the survivor can only be increased by a maximum of 100%.

ANNUAL EXEMPTION

Another way of reducing the Inheritance Tax bill would be to make use of what is known as either the annual exemption of £3,000 per year for each individual. This is effectively what you can give away each year, knowing that in the event of death, then the amounts up to that total will not be liable for Inheritance Tax. If the £3,000 exemption is not used in one tax year, it can be carried forward to the next year, allowing you to give away £6,000 the following year.

POTENTIALLY EXEMPT TRANSFERS

For a gift to be exempt from Inheritance Tax the person making the gift must live for more than seven years from the date of the gift. Otherwise, some Inheritance Tax is payable on a sliding scale.

The Inheritance Tax payable on the gift reduces on a sliding scale only if it was made between three and seven years prior to death. After the third year the tax paid on an Inheritance Tax liability such as this, reduces to 32%. It then continues to taper by 8% each year for the seven year period. If the person making the gift dies before three years have elapsed, no Inheritance Tax benefits are gained at all and the full tax amount is payable.

MARRIAGE GIFTS EXEMPTION

Certain people are allowed to make cash gifts of varying amounts to somebody getting married. A parent can give up to £5,000 to each of their children, including step-children and adopted children; up to £2,500 to a grandchild or children and up to £1,000 to anybody else.

SMALL GIFTS EXEMPTION

Each year you can give away £250 to any number of people without an Inheritance Tax liability arising.

NORMAL EXPENDITURE FROM INCOME

You can give away any amount of money from your normal income as long as the payments are made on a regular basis, into somebody’s savings account, for example. Essentially, you are giving away money instead of saving it for yourself. However, the gifts must not be so large as to diminish your usual standard of living.

OTHER INHERITANCE TAX EXEMPTIONS

You may also give assets to the following organisations during your lifetime or upon your death without Inheritance Tax being payable:

Gifts to Charities

Donations to Political Parties

Gifts to National Museums, Universities and National Trust

Donations of National Heritage property to certain non-profit making bodies

Gifts of land to Registered Housing Associations.

HOW MANY GIFTS CAN I MAKE?

You can make gifts under more than one of the above headings to the same person. For example, if your child is getting married, you could give £5,000 as a wedding gift and £3,000 as another gift and they would both be exempt from Inheritance Tax.

NON-BUSINESS ASSETS RELIEF

These include shareholding and investments in unquoted companies, including certain stocks listed on the Alternative Investment Market. These are free of Inheritance Tax if you hold them for at least two years.

BUSINESS PROPERTY RELIEF

Most types of business can qualify for business property relief. The only restrictions are for businesses whose main activity is dealing in stocks and shares, land, buildings or various other investments.

The extent of the relief will depend on the type of company involved. If you operate your business as a sole trader or a partner in a partnership you should qualify for 100% relief, meaning your business assets are disregarded for Inheritance Tax.

A lower 50% rate of business relief applies to a controlling holding in a fully quoted company. This applies to people who have control of the majority of voting powers on all questions affecting the company.

AGRICULTURAL LAND

Any farmland or forestry owned by working farmers can be left without any Inheritance Tax liabilities as long as it has been owned for at least two years. If the farmland or buildings have been let, they are treated as Potentially Exempt Transfers and you must survive for seven years in order for the property to be passed tax free.

WRITTEN INTO TRUST

It may well be that there are some Insurance or Life policies or Pensions that can be “written into trust” and then they would not be added into an estate and would be exempt when calculating the Inheritance Tax.

POLICY COVER

Another way of dealing with any potential Inheritance Tax bill would be to speak to an Independent Financial Adviser about taking out a policy to cover the cost of any potential Inheritance Tax. The quotations on any premiums for policies would of course be dependent on the extent of cover that you required.