Posted by Simon Misiewicz on 1st March 2014
Are you pained to be paying more tax on your property income than your spouse?
Do you feel ill for having a good job when you pay so much tax as a high tax rate earner?
In this series of articles we are going to focus on “Deed of trust”
- Deed Of Trust To Minimise Your Tax – Part 1 Income Tax
- Deed Of Trust To Minimise Your Tax – Part 2 Capital Gains Tax
- Deed of trust to minimise your tax – Part 3 Inheritance tax
So, let us get into the detail
Tax issues need to be diagnosed ready for a remedy to be implemented.
You can pay Inheritance Tax (IHT) if the assets in the trust are valued at more than £325,000. (1) (2) Individuals would pay 40% IHT above the £325,000 net asset value.
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 home in the UK – nor on any gifts you make to them in your lifetime – even if the amount is over the threshold.
Charity exemption Any gifts you make to a ‘qualifying’ charity – during your lifetime or in your will – will be exempt from Inheritance Tax. A donation to charity in your will may also reduce the rate that tax is paid at (see more in the link below).
Potentially exempt transfers. If you survive for seven years after making a gift to someone, the gift is generally exempt from Inheritance Tax, no matter what the value.
Annual exemption. You can give up to £3,000 away each year, either as a single gift or as several gifts adding up to that amount – you can also use your unused allowance from the previous year but you use the current year’s allowance first.
In most cases, you must pay Inheritance Tax within six months of the end of the month in which the deceased died. After this, interest will be charged on the amount outstanding.
You can pay in yearly instalments over ten years if the value of the estate is tied up in property such as a house.
In this example, none of the estate is left to charity. Value of Robert’s assets:
House = £300,000
Car = £7,500
Household goods = £2,000
Bank account = £19,000
Shares = £30,000
Premium Bonds = £500
Total value = £359,000
Value of Robert’s debts that can be deducted from the value of the estate:
Telephone bill = £55
Electricity bill = £45
Gas bill = £35
Funeral expenses = £865
Total deductions = £1,000
Net value of Robert’s estate = £358,000
Inheritance Tax is due because the net value of the estate is above the Inheritance Tax threshold of £325,000. Inheritance Tax is payable at 40 per cent on the amount over the threshold:
Net value of Robert’s estate = £358,000
Less threshold = £325,000
Amount subject to Inheritance Tax = £33,000
Inheritance Tax payable = £13,200 (£33, 000 x 0.4 (40%)
Interest is charged on any tax not paid by the due date, no matter what caused the delay in payment.
The amount of IHT is 20% (2) rather than 40% IHT for individuals (3). As you can see it is financially better to put properties into trust to save on IHT.
Applying the treatment
Now we have identified the treatment here are a few ways that you can apply it to your tax pains.
There are four main situations when Inheritance Tax may be due on trusts:
- When assets are transferred – or settled – into a trust
- When a trust reaches a ten-year anniversary of when it was set up
- When assets are transferred out of a trust or the trust comes to an end
- When someone dies and a trust is involved when sorting out their estate
For most types of trust Inheritance Tax is due when you make transfers that total more than the Inheritance Tax threshold (£325,000 in 2013-14 tax year). You work this out by adding up the value of any transfers (based on the loss in value to the settlor’s estate) and any chargeable gifts made in the previous seven years by the settlor. Inheritance Tax is due on everything above the threshold.
If the trustees pay, the rate of tax is 20 per cent. If the settlor pays the Inheritance Tax instead of the trustee, this means there will be an increased loss from the settlor’s estate. (4)
Immediate post-death interests and Inheritance Tax
If someone acquires an interest in possession from a beneficiary who has died – either under the beneficiary’s will or as a result of the rules of intestacy – the assets don’t count as ‘relevant property’. The beneficiary will continue to be treated according to the old rules for interest in possession trusts. This means there is no Inheritance Tax to pay at the ten year anniversary.
There will be no Inheritance Tax to pay as long as the asset stays in the trust and remains the ‘interest’ of the beneficiary (5).
18 to 25 trusts and Inheritance Tax
The Finance Act 2006 introduced a new category of age ’18 to 25 trusts’. A trust for a bereaved young person can also be set up as an 18 to 25 trust.
As with a trust for a bereaved minor the ten yearly and Inheritance Tax exit charges don’t apply for an 18 to 25 trust. However, the main differences are:
- The beneficiary must become fully entitled to the assets in the trust by the age of 25
- During the time that the beneficiary is aged between 18 and 25 Inheritance Tax exit charges will apply – the ten yearly charge can’t apply because the trust can only last for a maximum of seven years
Here are a few suggestions.
Always plan your strategy before buying properties. If you know that you are going to set up the property into a trust then be sure to buy the property “tenants in common” and get the deed set up soon after purchase. Or better still at the same time.
For the trust to work please ensure that:
- The property is bought in joint names under “tenants in common”
- A deed of trust is formed to allocate the money in accordance of the split you desire
- Complete Form 17 to notify HMRC that the income is to be split (8)
Plan ahead. If you die within seven years of making a transfer into a trust your estate will have to pay Inheritance Tax at the full amount of 40 per cent. This is instead of the reduced amount of 20 per cent which is payable when the payment is made during your lifetime. (4)
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