Inheritance Tax – What It Is And How It Affects You
If you would like to discuss your inheritance tax position on your estate or get a free evaluation of the potential liability on your estate, please call us to arrange an appointment. We are able to make recommendations on how to construct your will to reduce the amount of inheritance tax payable by your family. We can also refer you to our partnership company, New Forest Wealth Management, who will be able to make recommendations on how to reduce your inheritance tax liability over your lifetime.
Death duties have been with us for centuries, in the guise of Estate Duty, Capital Transfer Tax and now Inheritance Tax (IHT). Irrespective of the name, the purpose has always been the same: to raise revenue from the estates of citizens.
Inheritance Tax no longer only affects the wealthy. While most people are aware of the existence of IHT, it is a subject that gives rise to some distaste or lack of interest and many, not surprisingly, would rather delay consideration of the matter. The result is that as so few people do anything about their potential IHT liability, HMRC anticipates collecting over £4 billion in the current tax year.
Inheritance Tax is a tax on the transfer of assets on certain lifetime gifts and on death. As the name suggests, most charges to IHT arise:
- When transfers are made on death
- When Potentially Exempt Transfers (PETs) become chargeable because the donor has died within seven years of the PET (a failed PET)
- On Chargeable Lifetime Transfers (these arise from making gifts into some trusts) at the time of the transfer and/or because the donor has died within seven years of the CLT
The current rates of IHT on death are:
- 0% on the Nil Rate Band (£325,000 for tax year 2012/13)
- 40% on the excess
The following transfers are within the charge to IHT:
- All transfers of assets (worldwide) made by UK domiciled and UK deemed domicile persons, whether during lifetime or on death
- Transfers of UK assets made by non-UK domiciled persons, whether during lifetime or on death
Domicile is a very British concept that is totally separate from, for example, nationality or citizenship and refers to your status as subject to inheritance tax. Domicile for most people is acquired at birth. A legitimate child will acquire as their domicile of origin that of their father. An illegitimate child will acquire the domicile of their mother. That domicile stays with the individual for life unless they change it by adopting a domicile of choice or they become deemed domicile.
If an individual has been resident in the UK for 17 out of the previous 20 tax years, they are deemed to be UK domiciled for IHT purposes, even if still domiciled abroad for general purposes. In order to prevent individuals escaping IHT by moving abroad shortly before death, someone who changes their domicile remains UK domiciled for IHT purposes for 36 months after losing their UK domicile for general purposes.
SPOUSES AND CIVIL PARTNERS
Husbands, wives and civil partners are taxed quite independently of each other. On the death of one spouse/civil partner, it is necessary to value their estate, which only includes the assets (or share of assets) actually belonging to the deceased.
Each spouse/civil partner has the benefit of the Nil Rate Band, exemptions and reliefs independently of the other spouse/civil partner. Transfers between spouses and civil partners, whether or not living together, are usually exempt. There is an exception to this when one of the parties is non-UK domiciled.
TRANSFERABLE NIL RATE BAND
Effective from 9 October 2007, a surviving spouse (or civil partner) can use the unused percentage of their deceased partner’s Nil Rate Band (NRB) on their subsequent death, in addition to their own NRB. This can be utilised even if the first to die had no assets in their own name or did not pass the whole NRB onto their surviving partner.
Mr Lennon, English domicile, dies leaving everything he owns to his wife (English Domicile). He has an estate of £500,000, including his share in the family home. His estate pays no inheritance tax as it is an exempt transfer to his spouse.
Mr McCartney dies leaving £500,000 to his two children equally. He was never married. The first portion of his estate, up to the Nil Rate Band (NRB), is taxed at 0%. The rest is taxed at 40%. His estate will therefore have £325,000 @ 0% and then £175,000 @ 40%. His estate will therefore pay £70,000 in tax before his children inherit the remaining £215,000 each.
Mr Starr dies leaving an estate of £1,000,000 to his two children equally. He had survived his wife who left everything she owned to him when she died. He therefore has full use of her transferred NRB. This means that he has a NRB of £650,000 before he pays tax at 40%. His estate will therefore have £650,000 @ 0% and then £350,000 @ 40%. His estate will therefore pay £140,000 in tax before his children inherit the remaining £430,000 each.
Mr Harrison dies leaving his estate of £750,000 to his four children equally. Two years before he died, he gave £125,000 in gifts to his children. He was married but got divorced many years ago. He had used up £125,000 of his NRB by making gifts in the past seven years (failed PETS). He therefore has a NRB available of £200,000. The first portion of his estate is taxed at 0%. The rest is taxed at 40%. His estate will therefore have £200,000 @ 0% and then £550,000 @ 40%. His estate will pay £220,000 in tax before his children inherit the remaining £132,500 each. (You will note that HMRC is the biggest beneficiary of his estate.)
EXEMPTIONS AND RELIEFS
There are a range of exemptions and reliefs available to reduce the amount of inheritance tax an estate may face. A summary of the most commonly used are:
- Annual Gift Allowance - £3,000 per person per year (but not to the same person as you make the small gift allowance to)
- Small Gift Allowance - £250 to any one person each tax year (see note above about the restriction)
- Gifts out of surplus income
- Gifts in consideration of marriage
- Business Property Relief - certain business assets may qualify for either 50% or 100% relief from Inheritance Tax
- Agriculture Property Relief - certain agricultural assets may qualify for relief from Inheritance Tax
Call us now on 02380 879243 to discuss the potential inheritance tax liability on your estate.
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The information provided here is intended to address the types of questions that people are often concerned about.
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