Inheritance Tax – An Introduction |
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Mark Jackson writes about the key elements of inheritance tax.
In this age of austerity and cutbacks, we are clipping coupons for the supermarket, visiting websites to monitor petrol prices, yet when it comes to saving money through paying less tax, the UK tax payer appears indifferent.
According to the 2012 Tax Action Report from leading independent financial advice group, Unbiased.co.uk, "as a nation we waste up to £12.6bn each year. That’s an average of £421 per taxpayer that could be put back in your pocket – and in many cases it could be much more". The report shows that inheritance tax is the fourth largest tax wastage area and with this in mind we begin a series of articles looking at the allowances and tools available to reduce the amount of inheritance tax.
It has been said that inheritance tax is a voluntary tax, which is all well and good if you know your way around the raft of legislation, allowances and exemptions. So it is perhaps timely that we are starting a series of articles, covering ways in which to take action to reduce the burden of inheritance tax that needs to be paid.
So what is Inheritance Tax?
Inheritance tax known as Estate Duty was first introduced in 1796 primarily to help fund the war against Napoleon Bonaparte, this was replaced in 1975 by Capital Transfer Duty and renamed Inheritance Tax in 1986. In effect it is a Death Tax on the total sum of your Estate after all the Legal allowances have been deducted. The current level of assets you can hold on death before tax is levied at 40% is £325,000. You Estate value is calculated after:-
1) All debts on the estate, i.e. Mortgages, Bank, Loans etc
2) All Funeral Expenses
3) All Testamentary expenses, i.e. Cost of Probate
As part of the Probate process your Executors must complete the relevant Tax forms and return to HMRC and any Inheritance Tax
payable must be paid from the Estate prior to the Estate being distributed to beneficiaries.
Inheritance Tax can be a minefield but with proper planning you can minmise the tax burden or completely mitigate it. Over the course of these articles we will examine planning that can be done in your life time to mitigate IHT
In this the first part we'll begin to examine the use of gifts to reduce the burden of Inheritance Tax.
Exempt Beneficiaries or Donees
You can make gifts to certain people and organisations without having to pay any Inheritance Tax. These gifts are exempt whether you make them during your life or as part of your will. The HMRC website defines exempt beneficiaries as:
• your husband, wife or civil partner, as long as they have a permanent home in the UK - no marriage, no civil partnership, no exemption.
• a 'qualifying' charity established in the EU or another specified country
• some national institutions such as museums, universities and the National Trust
• any UK political party that has at least two members elected to the House of Commons or has one elected member, but the party received at least 150,000 votes
Make use of the Annual Allowance ( use it or lose it )
Current tax law allows you to reduce your estate and give away gifts upto £3,000 a year, every year without any stipulation as to who or how the gifts are made. A £3,000 gift could equate to a tax saving of £1,200. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don't use it in that year, the carried-over exemption expires. This is an important point to remember if you are completing a probate form, the estate could be reduced by £6,000, the value of a gift in the year of death and in the
year preceding death. Thus saving £2,400 in Inheritance Tax.
If it is a married couple then in 1 year they could give away £12,000 between them and then £6,000 per annum between them. This could be put into a trust for Children or Grandchildren – we will discuss the use of Trusts in a later article
Potentially Exempt Transfers (PETS)
During your Lifetime you can give away as much as you like without paying Inheritance tax as long as you survive for 7 years. This is called a Potentially Exempt Transfer or PET i.e. it is only Potentially exempt as if you die within 7 years it may then be liable for IHT. If the estate in question falls below the IHT band (£325,000 for an individual in 2012/13) then there will never be any inheritance tax to pay in any event. Assuming the individual died within 7 years of making the gift, then it is the amount above the nil rate band which will be chargeable to inheritance tax, subject to the taper relief available as described in the following table.
Taper relief table
In this age of austerity and cutbacks, we are clipping coupons for the supermarket, visiting websites to monitor petrol prices, yet when it comes to saving money through paying less tax, the UK tax payer appears indifferent.
According to the 2012 Tax Action Report from leading independent financial advice group, Unbiased.co.uk, "as a nation we waste up to £12.6bn each year. That’s an average of £421 per taxpayer that could be put back in your pocket – and in many cases it could be much more". The report shows that inheritance tax is the fourth largest tax wastage area and with this in mind we begin a series of articles looking at the allowances and tools available to reduce the amount of inheritance tax.
It has been said that inheritance tax is a voluntary tax, which is all well and good if you know your way around the raft of legislation, allowances and exemptions. So it is perhaps timely that we are starting a series of articles, covering ways in which to take action to reduce the burden of inheritance tax that needs to be paid.
So what is Inheritance Tax?
Inheritance tax known as Estate Duty was first introduced in 1796 primarily to help fund the war against Napoleon Bonaparte, this was replaced in 1975 by Capital Transfer Duty and renamed Inheritance Tax in 1986. In effect it is a Death Tax on the total sum of your Estate after all the Legal allowances have been deducted. The current level of assets you can hold on death before tax is levied at 40% is £325,000. You Estate value is calculated after:-
1) All debts on the estate, i.e. Mortgages, Bank, Loans etc
2) All Funeral Expenses
3) All Testamentary expenses, i.e. Cost of Probate
As part of the Probate process your Executors must complete the relevant Tax forms and return to HMRC and any Inheritance Tax
payable must be paid from the Estate prior to the Estate being distributed to beneficiaries.
Inheritance Tax can be a minefield but with proper planning you can minmise the tax burden or completely mitigate it. Over the course of these articles we will examine planning that can be done in your life time to mitigate IHT
In this the first part we'll begin to examine the use of gifts to reduce the burden of Inheritance Tax.
Exempt Beneficiaries or Donees
You can make gifts to certain people and organisations without having to pay any Inheritance Tax. These gifts are exempt whether you make them during your life or as part of your will. The HMRC website defines exempt beneficiaries as:
• your husband, wife or civil partner, as long as they have a permanent home in the UK - no marriage, no civil partnership, no exemption.
• a 'qualifying' charity established in the EU or another specified country
• some national institutions such as museums, universities and the National Trust
• any UK political party that has at least two members elected to the House of Commons or has one elected member, but the party received at least 150,000 votes
Make use of the Annual Allowance ( use it or lose it )
Current tax law allows you to reduce your estate and give away gifts upto £3,000 a year, every year without any stipulation as to who or how the gifts are made. A £3,000 gift could equate to a tax saving of £1,200. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don't use it in that year, the carried-over exemption expires. This is an important point to remember if you are completing a probate form, the estate could be reduced by £6,000, the value of a gift in the year of death and in the
year preceding death. Thus saving £2,400 in Inheritance Tax.
If it is a married couple then in 1 year they could give away £12,000 between them and then £6,000 per annum between them. This could be put into a trust for Children or Grandchildren – we will discuss the use of Trusts in a later article
Potentially Exempt Transfers (PETS)
During your Lifetime you can give away as much as you like without paying Inheritance tax as long as you survive for 7 years. This is called a Potentially Exempt Transfer or PET i.e. it is only Potentially exempt as if you die within 7 years it may then be liable for IHT. If the estate in question falls below the IHT band (£325,000 for an individual in 2012/13) then there will never be any inheritance tax to pay in any event. Assuming the individual died within 7 years of making the gift, then it is the amount above the nil rate band which will be chargeable to inheritance tax, subject to the taper relief available as described in the following table.
Taper relief table
Number of years Between Gift and Death
Less Than 3 Years 3-4 Years 4-5 Years 5-6 Years 6-7 Years More than 7 Years |
% of IHT Due
100% 80% 60% 40% 20% 0% |
Equivalent amount of IHT due
40% 32% 24$ 16% 8% 0% |
So you can give as much as you like away during your Lifetime just make sure you don’t die within 7 years if you give away more than your allowance!
Transferable Nil-Rate Band
A valuable addition to the nil rate band, is the allowance not used by a spouse on their first death. If everything was passed to the surviving spouse on the first spouse's death, then their nil-rate band can be transferred to the survivor. If the second spouse dies in the tax year 2012/13 for example, and the first spouse made no use of their nil-rate band (e.g. by not making gifts to children), then on the second death the maximum allowance will be £650,000.
Other Allowances
Spouse or Civil Partner Exemption
Your Estate usually doesn’t owe Inheritance tax on anything you leave to a spouse or civil partner who has their permanent residence in the UK – nor gifts you make to them in your Lifetime – even if the amount is over the threshold.
Small Gift Exemptions
You can make as many small gifts of up to £250 to as many individuals as you like Tax free
Wedding and Civil partnership gifts
Gifts to someone who is getting married or registering a civil partnership are exempt up to the following levels.
• £5,000 to children
• £2,500 to Grandchildren
• £1,000 to any one else
Businesses, Agricultural Holdings and Woodland
There are reliefs of up to 100% on certain types of these assets. We will discuss these reliefs in another article as they are quite complicated and there are lots of qualifying rules laid down by HMRC
Gifts Made out of Income
This is an allowance that most people forget about. You can give away IHT free money out Income that by doing so does not affect your standard of living. i.e. You have income of £50,000 per annum but you can prove that on average you only spend £35,000 per annum you could legitimately give away £15,000 per annum.
NB Just a note on all these allowances. If you are going to use them to reduce IHT the make sure you keep adequate records as HMRC may want to see them as part of completing the probate process and completing the relevant Tax forms.
May 2012
Disclaimer:
Transferable Nil-Rate Band
A valuable addition to the nil rate band, is the allowance not used by a spouse on their first death. If everything was passed to the surviving spouse on the first spouse's death, then their nil-rate band can be transferred to the survivor. If the second spouse dies in the tax year 2012/13 for example, and the first spouse made no use of their nil-rate band (e.g. by not making gifts to children), then on the second death the maximum allowance will be £650,000.
Other Allowances
Spouse or Civil Partner Exemption
Your Estate usually doesn’t owe Inheritance tax on anything you leave to a spouse or civil partner who has their permanent residence in the UK – nor gifts you make to them in your Lifetime – even if the amount is over the threshold.
Small Gift Exemptions
You can make as many small gifts of up to £250 to as many individuals as you like Tax free
Wedding and Civil partnership gifts
Gifts to someone who is getting married or registering a civil partnership are exempt up to the following levels.
• £5,000 to children
• £2,500 to Grandchildren
• £1,000 to any one else
Businesses, Agricultural Holdings and Woodland
There are reliefs of up to 100% on certain types of these assets. We will discuss these reliefs in another article as they are quite complicated and there are lots of qualifying rules laid down by HMRC
Gifts Made out of Income
This is an allowance that most people forget about. You can give away IHT free money out Income that by doing so does not affect your standard of living. i.e. You have income of £50,000 per annum but you can prove that on average you only spend £35,000 per annum you could legitimately give away £15,000 per annum.
NB Just a note on all these allowances. If you are going to use them to reduce IHT the make sure you keep adequate records as HMRC may want to see them as part of completing the probate process and completing the relevant Tax forms.
May 2012
Disclaimer: