Inheritance Tax Charge

The Tax Charge, in a nut shell

When you die Inheritance Tax (“IHT”) is charged on the value of your assets.

• If you have made any lifetime gifts of over £3,000 per annum (these are called potentially exempt transfers or “PETs”) and fail to survive each of the PETs by seven years then the value of the PET will effectively be added to the value of your other assets on death. If you survive the PET by seven years then the gift will become free of any IHT.
• There is however one major exemption, in that all gifts whether made during life or on death as between husband and wife and civil partners or to a charity are exempt from IHT.
• Therefore if your Will leaves everything to your husband/wife /civil partner, the Deceased’s estate on the first death would be exempt from IHT (no matter how large this was, £100,000 or £10,000,000) because of the spouse exemption.
• There is a Nil Rate Band (“NRB”) which is currently £325,000 on which no IHT is paid. The NRB is reduced by PETs made within 7 years of death.
• Effectively this NRB increases to £650,000 for a couple who are either married or in a civil partnership as the person who dies first can pass their entitlement (to the extent it has not been used up) onto the surviving partner. This transfer of exemption is commonly known as the Transferrable Nil Rate Band (“TNRB”).
• The remainder of the estate is taxed at 40% of its value over the NRB or the TNRB in the case of a couple.

The Problem

The difficulty for many people now is that with the effective freezing of the NRB over the last few years many estates remain taxable largely as a result of ever increasing property values which in many cases can result in the family home having to be sold in order to pay the IHT.

The new Main Residence Relief

From April 2017 there will be a new main residence transferable nil rate band (“RNRB”) (sometimes called the new family home allowance). This will work alongside the existing NRB and TNRB. (So that’s three types of nil rate band!) It will apply when a main residence (essentially the family home) is passed on to a direct descendent.

A direct descendent includes a child or grandchild (including adopted, foster children and step-children) but does not include siblings, nieces and nephews.

This allowance will rise gradually from £100,000 to £175,000 from April 2017 to April 2020 (£350,000 for a couple) which together with the £650,000 from the existing TNRB can result in a potential “£1 million nil rate band” and to a large extent will ease the tax burden on families.

It should be noted however that for those without direct descendants the basic NRB for individuals is being held at £325,000 and the main residence relief will not apply so it will not be possible, for example, to leave one’s family home to a niece, sibling, godchild, remoter relative or friend. Further, an equivalent allowance will not be given to those whose assets are not held in property but, for example in shares or savings.

So basically the new family home allowance will have no benefit to those without direct descendants or property!

There are measures in place to make sure that the RNRB does not discourage individuals from downsizing. Assets of an equivalent value, up to the value of the RNRB can be passed on death to direct descendants. These measures will only, however, apply to somebody who ceased to own their main residence on or after 8th July 2015 and only in a limited number of circumstances. To date these “downsizing provisions” have been rather opaquely drafted and it seems that only one “downsize” operation will qualify. Therefore if a person or indeed a couple downsize more than once then their executors will have to nominate which property will qualify when claiming the downsizing relief.

There is also discussion as to the extent the new provisions may or may not apply to a house or an interest in a house which is held in various types of trust.

For large estates worth more than £2 million there will be a tapered withdrawal of the main residence relief.

How can we help?

As you can see there are effectively three lots of nil rate band relief. The provisions are complex and there is much debate among professionals as to the precise interpretation of the legislation.

As can be appreciated, despite the availability of both the NRB, TNRB and from April 2017 the RNRB, inheritance tax planning remains a highly complex field particularly for families where there have been re-marriages, children to previous relationships or with special needs and indeed non-married partners who do not benefit from such generous tax breaks.

Additionally, those people without direct descendants or who are not home owners are much more restricted in making tax free dispositions other than to charities. Those with business and agricultural interests bring further complications to ensure that valuable reliefs are not lost.

Deeds of Variation

Even when a person has died all is not necessarily lost in effective inheritance tax planning. It may be possible within a period of two years from the date of death to vary a Will (or the dispositions made subject to the law of intestacy where a person dies without making a valid Will).

Such a variation can produce a more tax efficient result so saving potentially thousands of pounds. Such an arrangement is made by a Deed of Variation, sometimes known as a Deed of Family Arrangement.

There are also occasions where a trust (usually a life interest trust or a discretionary trust) may be advisable to deal with particular family circumstances (often where there have been re-marriages or perhaps where there are vulnerable beneficiaries) and it is in these cases that specialist professional knowledge is required. Trusts have their own complex tax regime.

Our Private Client department will be happy to discuss the alternatives that may be open to you and assist you in making a tax efficient Will benefiting your family or chosen beneficiaries.