Inheritance tax is often thought of as a voluntary tax on the common assumption that it can be easily avoided with a bit of foresight and some clever tax planning. Whilst this may be true in certain cases, for most large estates you can ultimately only avoid inheritance tax completely if you either leave most of your property to charity (or for the public benefit) or give it away during your own lifetime (with no reservation of benefit) and survive for at least 7 years.
Having said that, there are many ways to reduce your IHT liability quite substantially by taking advantage of all available allowances and reliefs. The most important of these is the nil rate band and your will should be structured so that maximum use is made of this by both spouses (or civil partners). The Government has made this a lot easier now by automatically allowing you to carry forward any part of the nil rate band that was unused on the death of the first spouse (or civil partner).
Inheritance tax was something that most people never had to worry about once, but with the growth in both home ownership and property prices over the last few decades more and more estates are being assessed for IHT. It is therefore very important for anyone passing on property, either before or after death, to write a will and consider the possibility of IHT reducing the value of their estates, even if initially it will all go to their spouse (or civil partner).
The self-employed and those with large shareholdings in trading companies have the considerable advantage of Business Property Relief. This can enable you to avoid IHT completely on shares, buildings, stock, fixed assets, working capital and anything used as part of a trade, provided you have owned them for at least 2 years. Similar provisions exist for woodlands and for agricultural land and buildings.
Discretionary trusts used to be an important part of IHT planning but have become less attractive since 2008 due to the increase in the tax rate on trust income to 50% in 2010. However, used correctly, they could still enable you to gain a tax advantage.
For further details, please refer to the following Information Sheets and Tax Tips:
Homer Simpson owned property worth £5 million which he left to his wife Marge when he died. It included business assets of £2m, investments of £2m and a house worth £1m. No IHT was payable on his estate as it was all exempt as a spouse transfer. Marge Simpson then died 2 years later and left the whole of her estate, worth £5.5 million by then due to gains in the value of the investments, to her children Bart, Lisa and Maggie. The business assets were still worth £2m and were exempted by Business Property Relief. After deducting her nil rate band of £325k and Homer's unused nil rate band, also worth £325k, her taxable estate was £2.85m and IHT at 40% was a whopping £1.14m. D'oh!
Bart invented a time machine and transported himself back to when his father was still alive. He managed to convince him to alter his will so that he left his business assets to the children. Upon his death, the children then sold the business assets to their mother in exchange for the investments of £2m. When she died, she left an estate worth only £3m consisting of the business assets and the house. The business assets were exempted by BPR and the estate was reduced by the 2 nil rate bands to £350k. Tax on this at 40% was £140k. A saving of £1 million!
As she had owned the business assets for 2 years, Marge made sure that they qualified for BPR in both estates. This saved tax of £800k being £2m x 40%. The remainder of the tax saving was on the investments, which gained in value by £500k. If these had been kept by Marge, the children would have paid 40% tax on this increase in value. By swapping them for the business assets straight after Homer died, they ensured that the increase in value occurred afterwards when the investments were in their name, thus saving tax of £200k. The only downside is that they will have to pay additional capital gains tax of £90k (18% of £500k) when they eventually dispose of the investments due to the lower base cost.
Of course, time machines don't really exist! If you want to avoid making the same mistake as Homer and landing your kids with a huge IHT bill, you need to get it right whilst you are still alive. Come and speak to us at Acumen so we can make sure your will is tax efficient.