In the 2015/16 tax year it is predicted that the number of estates upon which Inheritance Tax will be paid will be 35,000, up from a little under 18,000 just three years ago. According to Investors Chronicle magazine, before this Summer’s Budget, it had been predicted that in 5 years time, the number of estates paying Inheritance Tax would increase to 63,000.
However, because of the introduction of the new Main Residence Nil Rate Band on 6th April 2017, it is now estimated that in 5 years’ time, this predicted figure will decrease to 37,000 estates being subject to Inheritance Tax (1 in every 15 people dying in that tax year).
Inheritance Tax is charged at the rate of 40% on the value of assets above the Nil Rate Band which is presently £325,000, subject to certain exemptions and reliefs. Where assets pass to a spouse or registered civil partner then spouse exemption will apply so there will be no Inheritance Tax to pay unless there have been very substantial gifts to other family members (or indeed other individuals other than Charities) within the 7 years before death.
Where an estate passes to other family members (not to spouses or civil partners) then there will generally be an Inheritance Tax charge if the value of the estate on death (taking into account gifts made within the 7 years before death which are otherwise unrelieved) exceeds the available Nil Rate Band for Inheritance Tax.
Where assets pass to a spouse or registered civil partner on the first death then spouse exemption will apply and accordingly the Nil Rate Band for Inheritance Tax will be unused at that point. In respect of the survivor’s estate the transfer of the Nil Rate Band which is unused from his or her spouse will result in an increase of the survivor’s Nil Rate Band by 100% to £650,000.
We have set out below 9 points to consider when planning to mitigate Inheritance Tax.
1. Ensure that the Nil Rate Band and Main Residence Nil Rate Band are Utilised
First and foremost, clients should make sure that they use their Nil Rate Bands and residential Nil Rate Bands.
If an individual spouse has been previously widowed or widowered then there is potentially a third Nil Rate Band (but not as we presently understand it a third residential Nil Rate Band) which should be carefully protected in order that it is not lost.
Provided that the main residence is worth at least £350,000 then on 6th April 2020, up to £1million (£1.325million if a third nil rate band is available) can be passed onto beneficiaries (who must include children or grandchildren because of the residential Nil Rate Band) free of Inheritance Tax.
For couples who are not married or in a registered civil partnership it remains important to ensure that the Nil Rate Bands (and the residential Nil Rate Band in due course) are used on the first death because if they are not, there will be no transfer to the survivors. Clients in this position should consider using Discretionary Wills or old fashioned Nil Rate Band Discretionary Trusts in their Wills to ensure the Nil Rate Band and residential Nil Rate Bands are utilised on the first death and not wasted.
Where assets exceed the available Nil Rate Band (and the prospective available residential Nil Rate Band in due course) then clients might want to consider reducing their estates by planning during their lifetimes. For larger estates, clients should consider reducing their estates to below £2million. Where clients’ estates exceed this, the residential Nil Rate Band will be tapered. This will mean that an estate worth £2.2million in 2017 and £2.35million in 2020 to 2021 will enjoy no advantage from the residential Nil Rate Band.
2. The Main Residence Nil Rate Band
From 6th April 2017 onwards grandparents and parents will be able to use an additional Nil Rate Band which applies only to residential property. The level of this additional Nil Rate Band will be £100,000 on 6th April 2017 and will then increase on 6th April each year by £25,000 so that on 6th April 2020 the residential Nil Rate Band will have increased to £175,000 per person.
Given that for many people the majority of their wealth is comprised within the value of their home, the residential Nil Rate Band has the potential to make a significant difference to families. It is only applicable to parents and grandparents and can only be used where the home is being inherited by a direct lineal descendant although this also includes stepchildren, adopted children and foster children. In the same way that if the Nil Rate Band is unused it can be transferred to a spouse or civil partner for use on their death, the residential Nil Rate Band can also be transferred.
If the value of the share in the property is below the residential Nil Rate Band then the amount of the residential Nil Rate Band will be limited to that share in the property although any unused excess can be transferred to a spouse or civil partner (but only for use in respect of a share in the property in due course). There is also provision for a couple who have downsized their property (or perhaps even sold the property) after 8th July 2015 for residential Nil Rate Bands up to the value of the original property to be available.
It is also interesting to note that if a spouse should die before the introduction of the residential Nil Rate Band on 6th April 2017, the surviving spouse will still be able to make use of the transferred Main Residence Nil Rate Band, so long as they die on or after 6th April 2017.
3. Business and Agricultural Property Reliefs
Clients should also consider the extremely valuable Business and Agricultural Property Reliefs which are available for appropriate investments. For clients who have these reliefs, they ought to check to ensure that they are optimised (for example land owned outside a Partnership business by the individual Partners will only qualify for 50% Business Property Relief and not 100%).
For clients who do not farm and are not in business, there are investments available which will qualify for Business Property Relief after the minimum two year ownership period. These include some shares on the AIM market. Naturally professional advice should be sought from an appropriately experienced IFA in relation to such investments.
4. Gifts to which the seven year rule applies
If there is no Agricultural or Business Property Relief then clients can consider giving away cash, investments, property or other assets (although they will have to watch Capital Gains Tax on all but cash) and provided that they survive for the period of 7 years from the date of making the gift, then the gift will fall out of their Inheritance Tax “clock”.
5. Gifts with Reservation of Benefit
It is important not to overlook the reservation of benefit rules which mean that if an asset is given away and a benefit is reserved from it then the value of that asset will still be included in the value of the Donor’s estate at death. The simplest example of this is giving away a home and living in it rent free. For many clients with substantial pension incomes, it will be an attractive proposition to give away the house and pay a full market rent (which must be maintained at a full market rent until death). The payment of a full market rent will avoid the application of the reservation of benefit rules.
6. The Annual Exemption and Small Gifts Exemption
Individuals are allowed to give away up to £3,000 in each tax year without this being counted for Inheritance Tax purposes. In addition, they can make smaller gifts of up to £250 per individual and gifts on particular occasions, for example £5,000 to a child when they get married.
7. Gifts out of Income
Surplus income can be given away (provided that it can be clearly and properly demonstrated that it was surplus income) without it being taken into account for Inheritance Tax purposes.
Trusts can still be used very effectively for Inheritance Tax planning and for many Trusts, it will be possible to hold over the capital gain on assets which otherwise would be subject to a large Capital Gains Tax bill if they were given away to individuals during lifetime. However, fundamentally there is a limit of £325,000 on gifts into Trust within any 7 year period and any gifts above this will be subject to an Inheritance Tax charge of 20% of the value of the assets above this, with a further Inheritance Tax charge of 20% if the Donor should die within 7 years of making the gift into Trust, albeit that Taper Relief applies.
9. Generation Skipping
Where Inheritance Tax is likely to be an issue for a family then it may be worth asking grandparents to consider skipping a generation either by giving assets directly to grandchildren (but take particular care of the risk of divorce) or into a Trust for grandchildren.
Roy Jenkins famously said in 1986, “Inheritance Tax is, broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. This may be just a slight exaggeration, but is fundamentally correct, certainly with regard to IHT being, broadly speaking, a voluntary levy. Sensible (and legal) Inheritance Tax planning done in good time can and does make a huge difference to family wealth. Please don’t volunteer!
Our Private Client teams at Langleys in both the Lincoln and York offices are experts in Inheritance Tax planning. If you would like to discuss your Inheritance Tax affairs please contact Andrew Fearn, David Wood, Amy Allison, Amanda Voakes or Hester Mills in Lincoln on 01522 888555 or Hugh Thompson, Serena Brotherton or Marilyn Chalk in York on 01904 610886.