Property prices have been on the rise in the UK for some time – although figures published in the recent Spring Budget do suggest that this stratospheric price rise is gradually beginning to slow. But the huge increases in house prices we’ve seen over recent decades have been one of the main reasons why inheritance tax has started to hit more and more ordinary people.
Inheritance tax (IHT) is the money you pay to HM Revenue & Customs on assets in your estate – and with property prices so high, a good deal more of us have been getting stung for IHT.
So, if you’re likely to be hit by inheritance tax, what will the impact be? And how can you reduce that impact as much as possible through clear tax planning?
Paying the right amount of IHT
No-one wants to pay any more tax than is necessary. But we’re all duty bound to pay the right amount of tax for our circumstances. So what I’ll be talking about in this post is focused around legitimate and wholly legal tax planning – I’m not looking at the kinds of convoluted tax schemes you may have heard about in the news, and I’m certainly not going to talk about using any offshore planning in Panama!
There’s a very clear and immovable mantra when it comes to tax:
We can plan to avoid tax but not to evade tax!
Tax planning that helps you avoid certain tax liabilities is completely legal, above board and acceptable. Tax evasion, where you knowingly make plans to evade paying taxes you’re liable for, is illegal activity.
Firstly, I just want to be clear that inheritance tax is payable by UK domiciliaries – basically, if you were born in the UK you’re likely to be domiciled in the UK. If you were born overseas it’s possible that you may have a non-UK domicile, but its possible to become domiciled based on residence within the UK. If you are non-UK domiciled, you may still be liable for tax on UK assets.
So, with our foundations clearly outlined, what I’m going to do in this blog post is look at a few of the common IHT misunderstandings I’ve come across when dealing with clients over the last few years – and help you avoid the same challenges.
Misunderstanding 1: I’m leaving all of my estate to my family, so there won’t be any inheritance tax to pay
This is actually only true in part. If you’re a married couple or in a civil partnership, you can leave your estate to each other and there won’t be any inheritance tax on those assets.
The reason for this is that there’s a specific IHT relief for assets passing between spouses. However, where your estate exceeds the nil rate band of £325,000 and those assets are left to other family members or friends, inheritance tax will be payable at a rate of 40% – which could amount to a fairly hefty tax bill.
Misunderstanding 2: I won’t have any inheritance tax to pay on my property overseas
This is actually false – IHT is payable on any worldwide assets. In fact, you may even have tax to pay in the country in which the property is situated.
So, taking this into account, it’s essential to make sure you take legal advice in the country where your overseas assets are located. Some overseas properties are owned in a company to ensure they’ll pass to the beneficiaries you intend – and in many cases to reduce any potential overseas tax. Even so, they’re still taxable in the UK. In addition a foreign Will should be used to ensure your assets pass in the manner that you’ve planned.
It’s probably helpful at this point to outline what makes up an estate. Here’s a quick overview of the main assets that are likely to appear in your estate:
- All property – wherever these properties are situated in the world
- The contents of these properties
- Life assurances
- Stocks and shares
- Bank and building society accounts, including ISA’s
- Current accounts in a sole trader or partnership business
- Directors loan accounts in a personal company
- Life interest in a trust
- Less any liabilities such as funeral expenses, mortgages, loans etc
It’s worth noting that some of the above may have reliefs or exemptions available, so it’s always sensible to check with a professional adviser.
Misunderstanding 3: My joint estate is less than £1m, so I won’t have any inheritance tax to pay
This statement is based on the announcement in Budget 2015 that a married couple will be eligible to a new residence nil-rate band, which when added to the existing nil rate band of £325k will give each of you £500k – £1m between both of you.
But the intricacies of the new legislation mean that, in certain circumstances, the full £1m may not be available. Let’s take a quick look at this in more detail:
- Firstly, the new relief is only being introduced from April 2017. It starts at £100k, increasing to £125k from 2018, £150k from 2019 and £175k from 2020.
- The relief only applies where your property is left to one or more lineal descendants – so that will include your children, stepchildren, adopted children or grandchildren. If it’s left to a sibling there won’t be any relief available and those with no children won’t be able to benefit from the relief.
- If the value of your residence is less than the resident nil-rate band (RNRB) then the relief is restricted to the value of the property.
- Where more than one property is owned, executors can nominate which property to allocate the relief against – but only where it’s been used as a main residence. So buy-to-let properties and furnished holiday lets won’t qualify. Also, if you’ve made a capital gains tax election for principle private residence relief, this won’t apply for IHT purposes.
- If the value of your estate exceeds £2m before any reliefs then the relief will be tapered until after £2.2m in 2017/18 no relief will be available. The figure in 2020 will be £2.35m. This is likely to affect many business people who are likely to qualify for BPR on the value of their interests in their business – whether that be a company, sole trader or partnership, but when their estate is totalled before the relief they could end up losing it altogether.
- If you’ve downsized the scale of your property, there are provisions to enable the relief to continue. But, again, the small print needs to be checked if you’re going to do this to make sure you don’t jeopardise the relief.
Misunderstanding 4: I’ve given away assets so I wont have IHT to pay on them
This is true in the right circumstances. Provided that you survive seven years after making a gift, the value of the asset will fall outside of your estate.
However, you need to be very careful where gifts are made which you continue to benefit from. These are known as gifts with reservation of benefit (GROBS) and will continue to form part of your estate. An example of this may be a property that you gift to a child but where you continue to occupy the residence.
This kind of scenario wouldn’t be effective for inheritance tax as the value would still be brought into your estate upon your death. That isn’t to say that you shouldn’t make such gifts as they may be useful for other reasons, but you must remember that it won’t reduce your inheritance tax liability unless you pay a market rent for the use of the asset/property.
Misunderstanding 5: I can only give away £3,000 per annum tax free
There are several inheritance tax reliefs available for gifts, and the complexity of this can end up confusing people. So let’s take a look at the main available reliefs.
- The first one is that you can give away up to £3,000 IHT-free each year. However, that doesn’t mean this is the maximum you can gift. It just means that if you don’t survive seven years and the gift comes back into your estate that the first £3,000 of the gift won’t be taxable.
- If one year’s £3,000 gift allowance isn’t used, it can be carried forward for one year only. If you’re a married couple, or in a civil partnership, you can gift away £6,000 per annum.
- There’s an IHT exemption of small gifts of £250 or less that you make to individuals.
- Gifts that you make in connection with a marriage are also potentially exempt
- £5000 for parents
- £2500 for grandparents
- £1000 for all others.
- Gifts out of income – if you can show that you have surplus income, and that this is used to make regular gifts, then these will fall immediately outside of your estate and won’t be dependent on the seven-year rule. Examples of this include paying regular contributions towards your grandchildren’s education, or the running of cars etc.
Now you understand inheritance tax
Having ironed out the popular misconceptions around inheritance tax, I hope you’re now feeling more confident about the possible impact of this tax and the importance of long-term tax planning.
In the next part of this blog series, I’ll be running you through some of the most effective ways to plan to reduce your inheritance tax liabilities – and to make sure you’re protecting as much of yours and the next generation’s wealth.
If you’d like to talk to our Tax team about your inheritance tax, please do get in touch to arrange a chat over a coffee.