Basics of mitigating Inheritance Tax

Simon Misiewicz

Expat & Property Tax Specialist

11th January 2017

What is Inheritance Tax (IHT)?

Inheritance Tax is a death tax, which is payable to HMRC at the rate of 40% above your IHT lifetime allowance, which we will come to a little later.

Lifetime IHT allowance

Each person is provided with a nil rate band for IHT purposes of £325,000. A husband/wife or civil partnership would benefit from an IHT lifetime allowance of £650,000 as they each get the £325,000 amount.

If this nil rate band has not been used upon death, it may be passed onto your spouse.

Any assets that are in your own name in excess of the above amounts will be subject to HMRC Inheritance Tax at the rate of 40%.

Potentially exempt transfers (PET) - IHT planning

John has £500,000 worth of assets and he died. The estate would have to calculate John’s inheritance tax liability as follows:

– £500,000 gross asset value (please note that debts and any other liabilities reduce the gross asset value)

– £325,000 less the nil rate band

– £175,000 assets chargeable to IHT

– £70,000 IHT bill to be paid by the trustees

We have ignored the Residence Nil Rate Band (RNRB) as we pick this additional Inheritance Tax relief later.

If £200,000 value of assets were transferred (ignoring Capital Gains Tax for now) and they survived for more than seven years, then the IHT liability would be revised as follows:

– £500,000 original asset value

– £200,000 assets transferred

– £300,000 assets to be passed on

– £300,000 less nil rate band

– £0 subject to IHT

– £0 IHT liability

As you can see by some effective tax planning, the person would save £70,000 in IHT alone. At the end of the day, it’s your choice who gets the £70,000: your loved ones or HMRC.

A potentially exempt transfer (PET) is treated as exempt whilst the donor is alive. A PET will not give rise to a lifetime IHT charge. IHTA 1984, s.3A

A PET is fully exempt if the donor survives 7 years from the date of the gift. A PET will become a chargeable transfer if the donor dies within 7 years of making a gift. On the death of the donor within 7 years, an IHT charge will be levied and any tax will be payable by the recipient of the gift.

If there’s Inheritance Tax to pay, it’s charged at 40% on gifts given in the 3 years before you die.

Gifts made 3 to 7 years before your death are taxed on a sliding scale known as ‘taper relief’.

Years between gift and death  Tax paid

– less than 3  = 40%

– 3 to 4  = 32%

– 4 to 5  = 24%

– 5 to 6  = 16%

– 6 to 7  = 8%

– 7 or more =  0%

This means that any gift you make after 7 years will be free from HMRC’s Inheritance Tax

Residence Nil Rate Band (RNRB) to reduce IHT on your private residence 

Inheritance tax is currently charged at the rate of 40% on estates in the UK worth more than £325,000. The government also introduced a Residence Nil Rate Band (RNRB) in April, helping to protect the main home asset by another £175,000.

This means that someone with a high valued home would benefit from the £325,000 Inheritance Life Time Allowance and the Residence Nil Rate Band of £175,000, giving rise to a tax-free amount of £500,000.

I’m also advising investors that couples can also pool their allowances, meaning they could leave a total of £1m before any inheritance tax is due.

Even though most Estates don’t pay inheritance tax – just seven per cent at the HMRC’s last count – a long-term freeze on the amount you can pass on before IHT is due (£325,000), means that this percentage is likely to rise considerably in the future. Effective tax mitigation planning can help to offset this.

Avoid IHT and CGT by passing assets to a terminal person.

Asset transfers between husband/wife and civil partners mitigate the Capital Gains Tax charge. For this reason it is sensible to gift assets from the heaty person to one that is terminal (12 months or less to live).

Why is this beneficial?

On death assets are passed from the deceased to loved ones at market value, not the original value according to IHT 1984 S.160

Option 1: Example of CGT if dispose of a property before death

For example, Sarah and John own a buy to let property. The market value is £200,000 with a purchase price of £100,000.

The gain would be £100,000 if sold. Capital Gains Tax would be chargeable on this amount at say 28% as high rate taxpayers being £28,000 ignoring CGT annual exemptions.

Option 2: Example of CGT if you dispose of a property before death without a gift.

John died during the year and Sarah decides to sell the property.

As the above example, the asset has a market value of £200,000. However, John’s 50% share was transferred to Sarah at market value on his death being £100,000.

This means that the deemed purchase value is £100,000 for John’s portion (market value) and £50,000 for Sarah.

This means that Sarah only has a gain upon selling the property of £50,000.

The tax charge at 28% will be less at £14,000.

Option 2: Example of CGT if you dispose of a property after death, with a gift before death to the terminal person.

Before John died Sarah made a gift to John of her share of the asset.

John now owned 100% of the property in the last 12 months of his life.

On death, the entire share of the property, owned by John, is passed onto Sarah in his will. The value of the property is passed to her based on the market value being £200,000.

On his death, Sarah sells the property at a market value of £200,000. There is no gain as the deemed cost is the market value at death being £200,000.

This is one of the basics of mitigating inheritance Tax.

What other areas of risk around IHT400 can impact you?

The third area of risk for property investors when completing an IHT400 form is that of observing the correct legislation around tax liabilities. Every year, HMRC reviews IHT400 forms where the submissions do not meet current legislative requirements.

Keeping up-­to­-date with legislative changes is not easy, and searching through guidance is time-consuming, as I advised my buy-to-let landlord client during our wealth planning review meeting.

The fourth risk area when it comes to assessing inheritance tax liabilities that many property investors can fall foul of is around record keeping. Good record-keeping is essential.

An absence of clear and concise records can mean that information provided is not accurate, and these mistakes are in turn passed on to HMRC. This will also mean an inaccurate IHT liability is in place.

I advised my client that when completing form IHT400 it is the deceased’s records which they are required to obtain and rely on. This can cause difficulties if those records are incomplete.

The type of records which I advised my buy-to-let landlord client to retain include:

– Gifts. Although it is Gifts made within seven years of the date of death that are important, it’s advisable to keep records at all times.

– Lifetime Transfers: Keeping careful and detailed notes and valuations of lifetime transfers, and having access to detailed inventories of assets makes it easier to gather the relevant information to complete form IHT400 correctly.

Payment of IHT

IHT is payable by the estate within 6 months of the person passing. As an example, for someone that died in January, you must pay Inheritance Tax by 31 July. You will need to get a payment reference number before you can pay your Inheritance Tax bill. This is a 15 digit code and may be requested from HMRC using the form

You can pay your Inheritance Tax on things that may take time to sell in equal annual instalments over 10 years.

You must say on Inheritance Tax Account form IHT400 if you want to pay in instalments.

You’ll usually have to pay interest on your instalments. Use the calculator to work out the interest you’ll need to pay.

What you can pay in instalments

Houses – You can pay 10% and the interest each year if you decide to keep the house to live in.

Shares and securities – You can pay in instalments if the shares or securities allowed the deceased to control more than 50% of a company.

Business run for profit – You can pay in instalments on the net value of a business, but not its assets. Albeit you can claim Business Asset Rollover if the business was a trade activity (professional services, selling products etc)

Agricultural land and property – This is rare because most agricultural land and property is exempt from Inheritance Tax.

Unlisted shares and securities – You can pay in instalments for ‘unlisted’ shares or securities (ones not traded on a recognised stock exchange) if they’re worth more than £20,000 and either of these apply:

– they represent 10% of the total value of the shares in the company, at the price they were first sold at (known as the ‘nominal’ value or ‘face value’)

– they represent 10% of the total value of ordinary shares held in the company, at the price they were first sold at

– You can find the face value of a share and whether it’s an ordinary share on the share certificate.

Ways to minimise IHT - Lifetime allowances

Utilise your lifetime transfer of any amount and provided they live for seven years there would be no IHT. There could also be a Capital Gains Tax (CGT) liability if assets that have increased in value since purchase have been made (other than their main home because of Private Residency Relief).

£325,000 one person
£650,000 gift allowances and avoid IHT on this amount if die within 7 years into a trust

You can gift assets of more than £325,000 in any year, just not to trust without paying a 20% IHT entry charge.

As such you can gift assets of say £1m and not have any tax issues unless you pass away within 7 years.

Ways to minimise IHT - Increase debt

Increase the level of debt to reduce the amount of assets, which in turn reduces the amount of IHT. An example of this is lifetime mortgages on your own home (if unencumbered)

£425,000 net asset value
£325,000 IHT lifetime allowance
£100,000 Excess over IHT lifetime allowance
£40,000 IHT at 40% charged on the excess

Raise debt

£425,000 gross asset value from the above
£100,000 mortgage/loans – spend this money
£325,000 net asset value revised

£325,000 IHT lifetime allowance
£0 IHT

Care must be taken with mortgages. These will need to be paid off within 12 months upon the death of the mortgage holder, compared to IHT may be paid over a 10-year period.

Ways to minimise IHT - Pension contributions

Pension contributions. If you invest money into a pension it will decrease your bank account(s) and move the funds into a UHT shelter. It is also possible to sell IHT chargeable assets and reinvest the proceeds into a pension fund.

This is particularly useful if you have not made pension contributions for the last few years. You can go back 3 tax years in addition to the current year. Each person is entitled to contribute themselves (if they have enough taxable income) or via their limited company.

£40,000 current year
£40,000 prior year 1
£40,000 prior year 2
£40,000 prior year 3
£160,000 total allowed pension contributions

£64,000 Potential IHT saving (£160,00 X 40% IHT charge)

Not only will you save on IHT but you will also save

– Income Tax if you have personally made pension contributions

– Corporation tax if the limited company has made the pension contributions.

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