Inheritance Tax Planning
What is inheritance planning?
Death and taxes can’t be avoided but we can help you to help your nearest and dearest when the inevitable comes.
Inheritance or estate planning is all about planning for the future to look after your family and friends after you have gone: it is about growing and organising your wealth for their benefit when you die.
Inheritance planning can be done during your life to help set things up efficiently at the time of your death. If you do this, very little work on tax planning will have to be done after your death, but it is also possible to help reduce a person’s tax liability after they have died.
We will help you do this in a way which is tax efficient by:-
- Making a tax efficient will
- Ensuring that you use your tax exemptions and reliefs available– in some cases it is possible to transfer large sums to beneficiaries with no tax liability
- Considering gifts
- By setting up trusts
- Considering planning after someone has died
In the process of advising you we will consider not only how to limit inheritance tax (IHT) but also capital gains tax (CGT).
Tax considerations on estate planning
Inheritance Tax (IHT)
Inheritance Tax or IHT will arise when there is a transfer of value which usually means a person’s death. A transfer of value can also arise where you make a gift of your assets while still living (the 7 year rule – see below)
The amount of the transfer of value on death is usually referred to as a person’s estate, though for tax purposes you can subtract debts and funeral expenses.
We will look at the available tax exemptions and reliefs available at death to reduce the IHT liability. With gifts during lifetime there are a number of exemptions we can also advise on.
In many cases, lifetime planning can help reduce your eventual inheritance tax liability. Questions we can help you answer are as follows.
- How much?
- How much can be given away in a tax efficient manner?
- What could change your needs later on: the stuff you don’t like to think about like divorce or ill health
- The possible impact of inflation, property prices or stock market movements: be realistic.
- Which assets are most suitable to be given away?
- Property prices or shares may fall or rise substantially
- not only avoiding inheritance tax (for example where a gift may be tax free after 7 years) …but if the property is given away at one value and rises substantially there may be capital gains tax.
- What other options are there to outright gifts?
- putting property in trust:
- for flexibility in terms of when money passes on, and the choice of to whom it should be passed;
- to prevent youngsters inheriting until they are able to wisely manage cash.
- use of a Family Limited Partnership, which is suitable in rare cases.
- putting property in trust:
In advising you we will let you know the estimated cost of setting up and administrating different structures. There may be a host of ways to pay less tax but if the fees exceed or substantially impact on the benefits it may not be worthwhile.
If you are an elderly client we will seek an explanation for the gift you are being persuaded to make to ensure that there is no undue influence or pressure.
Rates of Inheritance Tax (IHT)
The basic position in relation to IHT is:-
- A charge of 0% for the applicable “nil rate band” (£325,000).
- A charge of 40% on the rest.
No IHT is charged on gifts made more than 7 years before your death.
If your husband or wife (or civil partner) died after 9 October 2007 you also have the benefit of any unused nil rate band.
A further change came in from 2017 with the introduction of an additional residence nil rate band, but only if the main residence is left to:-
- Your children;
- Your current spouse or civil partner;
- The widow, widower or surviving civil partner of a child who died before you unless they have remarried or entered a new civil partnership when you die.
There is also a “downsizing allowance” for the situation where an elderly person sells up to move into a cheaper property. The idea is so that you will not be penalised losing the additional nil rate band for residence if wishing to downsize in later years.
What are potentially exempt transfers (PETS)?
If you make a gift and die within 7 years of making it, it can be subject to inheritance tax. If you are thinking of making large gifts (anything over a few hundred pounds), you should seek advice on how to best to reduce this potential liability.
A number of transfers benefit from this relief:
- Gifts to individuals.
- Transfers to trustees for trusts for the disabled.
- Transfers to bereaved minor’s trust.
- Transfers to the trustees of an interest in possession settlement – certain types of settled property.
- Transfers to the trustees of an accumulation and maintenance trust.
If you make a gift and die more than seven years later no IHT is payable. If you die within 3-7 years some relief (tapering relief is available). Special rules apply with trustees.
Tapering relief to the rescue
If you do die with seven years of making a gift (which is greater than your nil rate band), all relief is not lost!
If you survive for 3 years after the gift is made tapering relief against IHT will kick in:-
- Transfers within 3 to 4 years before the death pay 80% of IHT chargeable.
- Transfer within 4 to 5 years of the death pay 60% of the IHT payable.
- Transfers within 5 to 6 years before the death pay 40% of the IHT payable.
- Transfers within 6 to 7 years before the death pay just 20% of the IHT payable.
Are there exemptions to the rules on lifetime transfers?
The answer is, ’yes’ in the following cases:-
- Gifts to your husband or wife.
- Gifts to charity.
- Small gifts below £250 in any one year.
- Your annual allowance (transfers of £3,000 per annum):
This could be a useful way of passing the wealth to your children over a period of time and avoiding inheritance tax. It should be noted that you can use your exemption from the last tax year if you did not use it then.
- Gifts in consideration of marriage (up to £5,000 per parent of the couple).
Normal expenditure out of the donor’s income. Potentially large sums may be passed to beneficiaries from your income, but strict rules apply and advice should be sought. Essentially, you need to make the gifts regular, from your income (rather than capital) and the gifts must not dimish your standard of living. This can be a complex area so please get in touch for further information and advice.
What happens when you die?
How does the taxman value your property for IHT?
Generally your assets are valued at the price expected if sold on the open market at the time given.
- no reduction for the impact of large amounts of assets “flooding” the market at the same time.
- Possible reduction if your death reduces the value of your business
- Co-owned property might be reduced in value by 10-15%, though not if a husband and wife are co-owners
What about the valuation of shares for IHT?
If you leave quoted shares in your estate the valuation is “one quarter up” for the lower to the higher price on the day. If the share price was 200p to 208p a valuation of 202p would be taken.
For unquoted companies a complicated valuation will be necessary taking into account factors such as:-
- How well your company is doing at the time of death.
- Other recent dealings in the shares.
- The percentage of your holding (a minority holding is worth less than a controlling interest).
- Pre-emption rights (if other shareholders have a first right to buy):-
HMRC will require a full description of the business, at least the last 3 years accounts, full details of any restrictions in relation to minority shareholdings and information about the rights in relation to each class of share.
Valuing related property for IHT
HMRC will take the value of the property together.
Example Agatha owns a complete antique dinner service worth £4000 and leaves half each to her two daughters Matilda and Maud. The value of each half is only £500. The taxman would take the value of £4000.
Other reliefs to Inheritance Tax (IHT)
You will be able to benefit from a number of reliefs in certain circumstances including agricultural property relief and business property relief.
Agricultural property relief
This relief covers agricultural land and pasture as well as the cottages, farm buildings and farmhouses and the land occupied. The land with the buildings has to be of “character appropriate to the property” otherwise HMRC might dispute it.
You will only benefit from the relief on the “agricultural value” of the land. This means the land as if it were used only for agriculture.
The relief will only apply if you lived on the land for agriculture for 2 years before the transfer or owned the land for 7 years and someone else in place farming it.
Permanent occupation by the husband or wife can also be included in the calculation.
The relief is either granted at 100% where you have the right to vacate possession immediately before the transfer or to obtain it within 12 months or in some cases 24 months from the date of the transfer. This also applies where there is a tenancy commencing on or after the 1st September 1995.
In all other places the rate of relief is limited to 50%.
In some cases relief can also apply to agricultural property held by trustees.
Business property relief
Note that this relief is not available on all types of businesses – notably investment activity. The type of investments you cannot get relief on include:-
- Commercial and residential rentals
- Grazing licences
- Caravan sites
- Holiday lettings in most cases
We can advise you on the likelihood of your business’ inclusion within the relief.
The level of the relief is as follows:-
- 100% on
- a business or interest in a business.
- Shares not quoted on the Stock Exchange (including the Unlisted Securities Market or the Alternative Investment Market)
- 50% on other assets which qualify for the relief
- shares quoted on the Stock Exchange if you had control, (meaning a 50% of the shares)
- land, buildings, machinery or plant owned by you personally but used by a partnership of which you are a member.
To qualify for the exemption, you have to have owned the property for at least 2 years immediately prior to the transfer. If spouse inherits the property from their husband or wife, they will be deemed as owning the property since the husband or wife acquired it.
It should be said that the relief does not apply if passed to a spouse by way of a lifetime transfer (as opposed to on death). Special rules apply in the case of lifetime transfer.
Please also note that business property held in Trust may also benefit from the relief.
Capital gains tax
In this section we will look at the rates, the calculation, and the exemptions to capital gains tax and then consider what happens on death.
Rate of Capital Gains Tax (CGT)
The rates you will be charged for CGT will depend on whether you are a higher rate tax payer.
- Taxpayer not in higher rate band
- General rate of disposal
- Disposals of residential property
- Taxpayer not in higher rate band
- Tax payer in higher rate band
The calculation is done by looking at your earnings in that tax year and the part which exceeds the threshold for higher rate tax which acts at 20% (or 28% if residential property) are below the level that will be taxed at 10% (or 20% if residential property).
There is also a special relief known as entrepreneur’s relief, which applies at a 10% rate.
Personal representatives and Trustees are charged CGT at the higher rate.
Calculation of Capital Gains Tax (CGT)
The way the chargeable gain is calculated is to take the money received for the asset. From this there is a deduction for the sales costs, how much you pay for it and improvement costs. For example, if a property had an extension built the cost of this would be taken into account.
If a loss has been made in a particular year these losses can be carried forward.
What exemptions to CGT are available
The following exemptions are available:-
- An annual exemption (this changes every year but allows each individual to have some capital gain tax-free; any gains over the annual exemption are taxed at normal rates).
On the sale of your only or main residence;
On the disposal of a property occupied by the beneficiary of a trust.
What happens to CGT value if the owner dies?
CGT dies with you, and inheritance tax is applied instead. When you die the property is revalued at the date of death. If the value has risen you will not have to pay CGT. Of course IHT comes into play so the taxman may catch up with you anyway!
But if you disposed of the property while alive, if there has been a rise in value, CGT may be payable, unless the property is your principal private residence.
What reliefs are there for Capital Gains Tax (CGT)?
There are a number of reliefs available which we can advise you on:-
- Transfers between a husband and wife (also civil partner).
- Hold-over relief: This allows for someone receiving a gift of the property not to pay tax immediately but only the time they later dispose of it. The donor and recipient but make a positive choice “election” to do this.
Note that other reliefs are available on business assets such as your business or personal company or shares in a company not quoted on a recognised stock exchange or agricultural property.
Although relief can also be available for other types of assets then those relating to businesses then we can advise you on some of these. We can advise you on the circumstances in which this would apply.
It should be mentioned that hold over relief for CGT does not apply where the person receiving the asset is living outside the UK.
This applies with
- a disposal of the whole or part of a business:-
- It has to be the business or part of a business as a going concern or the assets used in the business following its cessation.
- a disposal of company shares where
- the company is a trading company
- the shareholding is at least 5% in terms of voting rights
- the person transferring the shares is an officer or employee of the company,
- all the above for at least 1 year before the date of the disposal or the company ceases to trade.
- A disposal of the assets owned by an individual which are used by a partnership or company where that person was in the last year a
- Partner (over 5% share) or
- their personal company (over 5% share) and they were an officer or employee
- The disposal of external investors of shares in unlisted trading company provided
- newly issued shares
- the company is unlisted and they have been
- issued by the company on or after 17 March 2016 and held for a period of 3 years from 6 April 2016 as well as being continually held for 3 years before disposal.
Is Entrepreneurs’ relief automatic?
No, the relief has to be claimed for:
How much is the relief?
The effect is for the net gain in the value of the asset is taxed for CGT purposes at 10%.
Are there are limits to Entrepreneurs’ relief?
Yes you will be subject to a lifetime cap for disposals after 6 April 2011, this is £10 million.
What happens if someone ceases to be a director and sells their shares at a later date?
There could be a risk of losing the relief, so in such a circumstance it may be appropriate to remain as director.
Can Entrepreneurs’ relief be made use of in settlements?
In certain circumstances this is possible and we can advise you on this.
Transfers between spouses and civil partners
One of the aspects of estate planning we will advise you on is distribution of assets between two spouses or civil partners. There may be good reasons to consider equalising assets to provide security for a surviving partner.
In the case of insurance on the life of one spouse or civil partner it will be important to consider having the policy written in trust. This is because if the policy is not in trust it will pass into your estate and may be taxed.
Sometimes the insurance policy is also taken out on the life of another such as a non-working wife to cover the cost of childcare/looking after home in the event of her death.
The matrimonial home
One aspect of your estate we will usually advise on is the ownership of your home. In most cases there will be co-ownership between spouses or civil partners.
There are two forms of co-ownership, the first being joint tenancy where in the event of one of the partner’s dying the other automatically becomes the sole owner of the property. No inheritance tax in payable on that change of ownership if your spouse or civil partner owns the other half.
The alternative is to be a tenant in common, which means that each partner has a proportion of the ownership. The difference is that in the event of death your share would pass under your estate rather than going automatically to your spouse or civil partner. The deceased’s will is therefore followed when dealing with their share of the property.
Another point when to consider when planning your estate is having an insurance policy to cover the mortgage in the event of the death of one partner.
Joint ownership of property other than the matrimonial home
It can be impractical for certain assets to be held jointly. This will assist the surviving number of the couple to make use of the assets immediately on death without having to go through the estate. An example would be a joint bank account so that the surviving partner can carry on using this.
Joint ownership will not always be beneficial from an IHT point of view. This could be the case where the estate exceeds £2 million pounds. We can advise you if this is likely to be the case.
From an income tax point of view there is a general assumption that the benefit is owned 50:50. However, a declaration can be made to the tax man of the income is in fact distributed between them. It can be useful to consider this point in the event that one of the partner’s pays tax in the higher rate band and the other is in the lower rate band.
From the point of view of CGT where an asset is transferred into the joint names of a husband and wife from their sole name there would be no CGT payable at that time. If the property is then sold each party will have 50% of the tax liability. The advantage of this is that both have exemption which means that an additional £12,000 (2019/2020 figure) of gain may avoid taxation. Also, if one of the partners a higher rate tax payer and the other not, the lower earning partner will pay CGT at a lower rate.
Passing assets over wholesale to the partner
This approach to planning will be particularly advantageous where one of you is wealthier. This means that both will make the best benefit of tax allowances.
In the case of income tax the spouse may make better use of his or her personal allowance. With Capital Gains Tax (CGT) the matter can be transferred without there being a chargeable gain between husband and wife, also the partner. This will enable both partners to benefit from the annual exemption on CGT.
In relation to Inheritance Tax there are various ways that savings can be made to make best use of reliefs if to make to the children for example. Each spouse may gift £5,000 when a child marries and an annual gift of £3,000.
It should be noted that unused nil rate band of Inheritance Tax is transferred between spouses. The additional residence nil rate band can be transferred to spouse if unused. It must be remembered that this may be lost if the value of the estate overall exceeds £2 million pounds.
Passing property to your children during your lifetime or on death
We can advise you on how to pass property. While it will not always be possible to avoid tax we can discuss how to minimise the tax you pay and the different options available. Property may be transferred as a gift during the lifetime of the parent or for a trust or by the will on your death.
Small amounts of money will often be transferred as gifts. However with larger gifts you should consider a trust. You can use a trust if the child is a minor or there is a concern about whether young adults will use the money responsibly.
How are outright gifts taxed?
You will need to consider Inheritance Tax (IHT) and Capital Gains Tax (CGT) and where these taxes interact.
Inheritance Tax on gifts
Gifts made whether in Trust or directly will be considered to be a Potentially Exempt Transfer (PET) when made. “Potentially” is used because it depends how long you live after making the gift.
For an outright gift no tax is payable immediately. However if a gift is to a trust a charge at half the death rate (so 20%) is made unless it is a Trust for a disabled person. However, no tax is payable if you live for 7 years after making the gift.
The bad news is that if the donor dies within 7 years the gift will be taxed. The good news is that any increase in value of the property over that time will not be taxed.
Of course, there is an element of speculation about the likelihood of surviving for 7 years. It is possible to get an insurance policy against the likely tax “hit” if you die within 7 years.
If the property loses value between the time it is given and death within 7 years the lower value is taken in calculating tax. However, this does not apply when it comes to cash so your child or other person you are giving to cannot benefit from the effects of inflation!
If you make a number of gifts on the same day, the same amount of IHT will apply once the nil rate band of the tax is exceeded. However, if some gifts are given earlier and later and the later ones take the value of the estate over the nil rate band it is the later recipient who may be taxed, depending on what remains in your estate when you die.
The order of gifts is also important with certain types of settlements known as “relevant property trusts”. The rules in this area are complex and we can advise you on them because they can have significant indications.
One question to consider is whether it makes any difference to taxation if a payment is received as a gift or under a will. If the gift is made and is taxable it will have the benefit of any nil rate band before gifts under a will. This means that if a gift is made and death occurs within 7 years someone receiving the benefit of a gift could be best placed than someone receiving money under the will. This is because the gift could have used up the nil rate band.
We will also be able to advise you on the best way to reuse certain reliefs if the property in question falls into the category to which business property relief for agricultural property relief may apply. Only certain types of beneficiaries can make use of this relief and we will need to advise you on this aspect so that there is no waste of the relief.
Certain types of property can be excluded such as an “interest in remainder” following a “qualifying life interest”. This arises if you give your spouse property to benefit from during his or her lifetime with the remainder to go to a child.
We can advise you on complex scenarios such as the example above where very significant savings in fact can be made in where an estate is valued in the hundreds of thousands rather than in the millions.
Gifts and Capital Gains Tax
Capital Gains Tax may apply to a gift. This would occur if you made a gift or property which has increased in value since it was acquired.
The value when you acquired the property is taken as the cost of acquiring the property and tax charged on the resulting amount. In some cases, this may not be an issue because of the annual exemption.
In some cases of business assets holdover the relief may apply. the Thomas Mansfield team will advise you on the interaction of the various reliefs and exemptions to Capital Gains Tax (CGT).
It should be noted that Capital Gains Tax (CGT) is normally paid on the 31st January following the end of the tax year when the disposal (in this case a gift) was made. There are some cases where it can be paid in instalments such as where the consideration is payable over a period of 18 months and paid immediately would be a hardship. Instalments may be paid up to 8 years. In the case of gifts or disposals by Trustees this can also apply for certain types of assets.
Income tax on gifts
If you give an asset to an adult child income tax will be payable. The benefit there can be that the child may be in a lower tax bracket or indeed may not receive income over their personal allowance whereas you may be paying tax at higher rate, which in some cases could be as high as 45%. There is clearly a tax benefit from this. However, this rule does not apply if the child is a minor.
Gifts into trust
You may wish to consider making a gift into trust to keep flexibility. For example, you may wish to make the gift to your child for them to receive the benefit at the age of 21 with the assets passing to another child if they do not reach the age of 21.
If income is paid out under a trust it will be treated as a parental income (and charged at their appropriate rate which of course may be a higher rate income even at 45%) but not if the income is accumulated.
Gifts with reservation of benefit
There is special provisions covering the situation where you make a gift to, say, your child but continue to receive the benefit from it. HMRC may look at this as a kind of fictional gift and there are special regulations to catch this.
Jemima gives her Ming vase to her daughter Beatrix but keep it displayed in her own living room. If Jemima dies within 7 years Inheritance Tax will be payable as a potentially exempt transfer. There could also be a second charge for IHT because of special rules to catch “reservation of benefit” This could lead to double taxation but this is relieved by certain special regulations.
The moral is: a gift with reservation of benefit does not avoid Inheritance Tax. However, there may be situations, which are not caught by the rules. Some examples are:-
- Where you gift a property and stay there for less than 1 month in the year or less than 2 weeks if either child you have given the property to is absent.
- Social visits excluding overnight stays.
- A temporary stay for a short term purpose.
These are just 1 or 2 examples. Again, we can advise you on these complex rules.
The family home
When we help you plan your estate, a crucial area for consideration is the family home because this provides for the maximum number of tax saving opportunities. However, it is also most people’s main asset so care needs to be taken when considering them and professional advice is essential.
Issues for you to consider are:-
- Insurance cover. It is sensible to have life insurance in place to cover the mortgage in the event of death. If made in Trust this may be tax free when paid out.
- Whether to have a joint tenancy or a tenancy in common.
- Main residence exemption for Capital Gains Tax (CGT): Sometimes issues are:-
- if there separate buildings on the same property: There have been a number of cases on this such as where a separate bungalow occupied by a caretaker was not found to be within the exemption complications can also arise where some of the land is sold and part retained and then disposed of later on.
- If part of the home is used exclusively for business purposes
- if you have more than one residence an election can be made but only if it is within 2 years of acquiring the second residence
- if you are married or are in a civil partnership you can only have one main residence between you
- when you move out the last 18 months you lived in the property are disregarded
- if you are waiting for up to 12 months for building works to be completed on your new home this is disregarded
- if the beneficiary has an interest in possession and lives in the property they can also benefit from the exemption. This may also apply even if the trust is discretionary but subject to certain rules.
It should also be noted that since 6 April 2015 special rules were introduced to limit the benefit of the main residency exemption for those who only spent limited time within the UK.
What are the considerations when we are advising on planning the estate and the family home?
It would often be most practical when dealing with your husband or wife to look at joint tenancy resulting in the property transferring with no tax at that stage. This would not in all cases be the most tax efficient way of passing on wealth to your children because gifts can be entirely exempt from Inheritance Tax after 7 years.
Note that there is a new residence nil rate band in force since 2017/2018 rising originally from £100,000 a maximum of £175,000 (with a cap of £2 million pounds on the value of the estate). This is only available where a residence is inherited by direct descendants. A special provision allows for it still to be enjoyed by those who inherit even if you “downsize” to move into a home with lower value and free up cash, for example.
Gifts to charity
Any gift whether made during your lifetime or under a will is exempt from Inheritance tax (IHT).
In order to encourage gifts to charity there is also a special provision that if 10% of the total estate is left to charity a lower rate of 36% on the balance for taxable part of the estate would be applied.
Capital Gains Tax (CGT) and charitable gifts
There will not be a taxable charge in this case as it will be considered that the asset is passed with no gain and no loss.
Charitable gifts and income tax
For higher rate taxpayers some savings can be made on income tax by making charitable gifts in certain circumstances. One example is Gift Aid.
Stamp duty/stamp duty land tax
Stamp duty applies to shares and other marketable securities with a consideration of £1,000 or more.
Stamp duty land tax applies to transactions in land in exchange for consideration save where exempt. Depending on the value of the transaction it may be exempt and different rates will apply according to the value of the property. There is an additional 3% payable if the property purchased is a second property. If you buy a property the tax man will decide as a matter of fact which is your main residence.
Special provisions will apply in the case of trusts.