For more than 300 years, estates in the UK have faced some sort of tax. Modern Inheritance Tax (IHT) dates back to 1894 when the government introduced a death duty in an attempt to pay off a £4 million deficit.
The latest figures show that IHT raised £5.2 billion for the Treasury in the 2019/20 tax year, with just under 4% of UK deaths resulting in a tax charge.
In the coming years, it’s expected that more and more people will be affected by IHT. Rising property prices coupled with a five-year freeze in the threshold for paying IHT mean more and more estates are likely to exceed the IHT nil-rate band.
Thankfully, good planning means that there are many ways to mitigate a potential IHT bill on your death. However, the rules are complex – as almost 2,000 people have recently found in an HMRC crackdown that is set to see individuals pay £600 million in tax. Read on to find out more.
Making an “outright” gift can avoid tax issues
One of the most common ways that you can reduce the value of your estate for IHT purposes is by making gifts. Typically, any gift you make will fall outside your estate provided that you live for seven years after making the gift. This is the “seven-year rule”.
However, if you want a gift to be exempt from IHT, you can’t continue to benefit from the asset in any way. If you do, the gift will be deemed a “gift with reservation of benefit”. No IHT exemption will apply, and the gift will be counted as part of your estate on death.
Examples of such gifts might include:
- You gift a property, but you want to carry on living in it
- You give away money to your children as a loan note so you can retain control in case your children later divorce and you want to avoid in-laws taking family money
- You give away shares in a family company but continue to drive a company car
- You gift a holiday home but continue to use it for free.
It’s important to note that, in the example of property, you can gift property, continue to live in it, and it will fall out of your estate for IHT if you survive for seven years. However, you must pay rent at market rates and not a token subsidised amount while you’re living in the property.
HMRC cracks down on more than £600 million of gifts
A recent report from the Telegraph has found that almost 2,000 people who made more than £600 million in gifts have been deemed ineligible for tax relief.
HM Revenue & Customs (HMRC) have investigated thousands of cases and have decided to levy a tax charge on 1,830 estates. This is where HMRC have discovered that the individuals who made these gifts continued to benefit from the assets given away. Gifts worth £624 million have been caught since 2016.
The newspaper reports that the true figures “are likely to be much higher, as death duty returns can take months or even years to be settled”.
Almost three quarters of these gifts related to property. Almost 13% related to cash transactions, gifts of shares and other securities made up a further 8%, and the remainder were classed as “other assets”.
Good advice can help you to avoid tax issues
While you may think that simply giving away assets solves a potential IHT problem, the complex rules mean that taking advice can help you to avoid costly mistakes.
Using the example of property, gifting a home more then seven years before your death might seem like a straightforward way to reduce the value of your estate.
However, as we have seen, unless you pay a market rent on the property until the day you die, the exemption may not be available. This monthly commitment could have a serious impact on your cashflow.
Also, any rent you pay gives rise to an Income Tax bill for the person you gifted the property to. They will also have to pay Capital Gains Tax, assuming they already own their own home, when you later die, and the property is sold.
Working with a financial planner can help you to plan your estate in a tax-efficient way. This might include:
- Making the most of your annual IHT gifting exemptions. Each individual can gift up to £3,000 in the 2021/22 tax year and make unlimited small gifts of up to £250
- Leaving a legacy to charity. The Telegraph report that tax-free gifts to charities have increased by 61% – these gifts fall outside your estate and, if you leave more than 10% of your estate to charity, any applicable IHT will be paid at 36% rather than 40%
- Creating trusts to manage the transfer of wealth to future generations
- Increasing your spending so you can enjoy your life.
If HMRC find any discrepancies in your planning, it is the executor of your will that could be hit with an unexpected tax bill. So, if you want to ensure you pass more of your wealth to your loved ones and not HMRC, good advice is key.
To find out how we can help you, email firstname.lastname@example.org or call us on 01189 876655.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.