18 November 2023
The future of inheritance tax (IHT) is unclear, with talk of a Labour government limiting IHT reliefs, or IHT being scrapped altogether under the Conservatives. With all of this uncertainty, it may be appealing to go back to basics and consider some straightforward IHT planning options in order to ensure some clarity over your and your family’s position whatever happens next.
IHT planning – the basics
The headline rate of IHT is currently 40%, but the IHT regime has a number of basic exemptions and allowances that are available to mitigate tax charges.
Transfers to a spouse or civil partner domiciled in the UK are exempt from IHT, as are gifts to UK charities. There is no cap on these exemptions so an unlimited value of assets can be transferred to such recipients without creating a current or future IHT bill.
Gifts from surplus income
Making regular gifts from surplus income can be a valuable IHT planning tool. For such gifts to be exempt from IHT, they must be made from income, not capital, and after they have been made the donor must be left with sufficient income, taking one year with another, to maintain their usual standard of living.
Evidence of intent to establish a regular pattern of gifting should be maintained, as should evidence that average gift values are lower than excess income receipts. The process requires a degree of management and review, but for anyone receiving large pensions or regular dividends, it can be very effective.
Other gifts to family and friends, not covered by other minor exemptions such as the small gifts allowance, are called ‘potentially exempt transfers’ (PETs) and attract no IHT providing the donor survives seven years from the date the gifts are made. Tax rates begin to reduce once the individual survives the gift by at least three years, so savings can be made even if they do not survive the gift for the full seven years.
Nil rate band
Every individual has an IHT nil rate band (NRB) of £325,000. If it is not used, the NRB can be inherited by a spouse/civil partner, so many couples will be able to pass on assets of £650,000 in total at an IHT rate of 0%.
Residence nil rate band
The residence nil rate band (RNRB) operates alongside the general NRB. It is available where a property that has been a person’s residence passes to a lineal descendant on death. It is not available on lifetime transfers of property.
The RNRB is reduced by £1 for every £2 by which the value of an estate exceeds £2m. Making lifetime gifts to reduce the estate value below £2m can maximise the tax relief available.
Investing in assets qualifying for business relief (BR) can substantially reduce the value of an estate for IHT purposes. For example, the value of shares in unquoted trading companies (including AIM listed shares) is reduced by 100% for IHT purposes once they have been owned for two years.
Labour has raised the possibility of abolishing BR, so it is worth considering whether it is appropriate to give away qualifying business assets now, taking into account both tax and commercial circumstances.
Capital gains tax
IHT is not the only tax that needs to be considered on a gift, because gifts are generally treated as a sale at market value for capital gains tax (CGT) purposes. It may be worth suffering a 20% CGT charge to save 40% IHT, but there is a risk that if someone dies shortly after making a gift, both CGT and IHT will be paid on the same assets. This problem can be avoided for assets qualifying for BR because the gift of business assets generally qualifies for CGT holdover relief, which has the effect of deferring any capital gain until disposal by the new owner. This is still not the whole story though because assets are revalued for CGT on death, so if BR remains available it could be better to retain qualifying assets until death.
Seeking professional advice is a must in this complex and often personally sensitive area of tax planning.
For more information, please get in touch with Andrew Robins, Laura Greenhill or your usual RSM contact.