Once the preserve of only the UK’s wealthiest families, inheritance tax (IHT) is now affecting an ever-expanding number of taxpayers – and a record portion of their estates is expected to be paid over to HM Revenue & Customs this year.
Escalating house prices and inflation, together with the fact that the IHT ‘nil-rate band’ threshold has not been increased from £325,000 since 2009 (and is set to continue until at least 2028), has brought more and more taxpayers into scope.
IHT is a tax on the worldwide estate – property, money and possessions – of anyone who dies domiciled in the UK. At 40% of any value of an estate over £325,000, IHT represents a substantial potential liability. Projections indicate that the UK Treasury is set to rake in £7.6 billion from IHT in fiscal year 2023-24, a rise of £500 million from the previous year.
There are, however, a number of further exemptions that can be used reduce your liability significantly.
If you own a property on your death, your estate can also benefit from the residence nil-rate band if the property is ultimately left to your direct descendants, such as children or grandchildren. The residence nil-rate band is currently £175,000. This effectively increases the IHT threshold to £500,000.
If you are married or in a civil partnership, you can transfer your entire estate to your surviving spouse or civil partner, tax free when you die. This means the surviving spouse or partner can inherit your whole estate without having to pay any IHT.
You can also pass any unused nil-rate band or residence nil-rate band to your surviving spouse or civil partner on death. If you did not use any of your nil-rate bands, your spouse or civil partners could potentially be topped up by 100%, leaving them with a nil-rate band of £1 million when they pass.
A potentially exempt transfer (PET) allows an individual to make gifts of unlimited value that will become exempt from IHT if the transferor survive for seven years after making the gift. Gifts can include money, property or land, stocks or shares, and personal possessions.
If the transferor does not survive for seven years after making the gift, the gift will still form part of their taxable estate, but taper relief may be available depending on when the gift was given. Gifts given up to three years before your death will be taxed at the standard IHT rate of 40% but the rate drops to 32% in the fourth year, 24% in the fifth year, 16% in the sixth year and 8% in the seventh year. At the end of the seventh year, it is wholly exempt.
To safeguard against potential IHT liabilities, individuals can acquire insurance during their ownership period or for the seven-year period after a gift. While this does not reduce IHT exposure, it provides immediate liquidity to cover the liability without the need to sell an asset that is intended to remain in the family for generations.
There is a significant potential trap to avoid here. If you make a gift but still have an interest in it, for instance you gift your home to a child but continue to live there without paying a commercial rent, then the house will not qualify as a PET. It will still be considered as part of your estate and chargeable to IHT.
There is no IHT payable on gifts to a spouse or civil partner during your lifetime if they are living permanently in the UK. Everyone also has an annual exemption of £3,000, which allows them to give away a total of £3,000 worth of gifts each year, whether to one person or split between multiple people, without such gifts being considered a PET. It is only possible to carry an unused annual exemption forward for one tax year. It is worth noting that the annual £3,000 gift allowance has now remained unchanged since 1981.
Any ownership of a business or share in a business will be included in your estate for IHT purposes, but your executors can apply for Business Property Relief (BPR) of either 50% or 100% of some assets, provided the deceased owned the business or asset for at least two years before death.
To claim BPR, a business must be wholly or mainly trading. This is determined by the ‘Balfour Test’, which assesses the trading and investment elements of the business in terms of turnover, profitability, capital values and the time spent on various activities. If the business qualifies, then IHT relief is available on the full value of the business. Balfour compliance should not be left to the last minute. It relies on the rigorous planning.
You can also, subject to certain conditions, pass on agricultural property, either during your lifetime or as part of your will, without having to pay IHT. Agricultural Property Relief (APR) is available on gifts of land occupied for the purposes of agriculture, together with appropriate buildings and farmhouses used in conjunction with that land.
The property in question must have been either occupied by the owner for the purposes of agriculture for two years prior to the gift or owned for seven years and occupied by someone else for the purposes of agriculture throughout that period. There are further conditions regarding the occupation and use of that land that will determine whether the rates of relief will be either 50% or 100%.
It should be remembered that farm assets, such as equipment and machinery, livestock, derelict buildings or harvested crops, do not qualify for APR. Where APR is not available, however, diversified businesses may be able to claim BPR on other assets.
Certain pensions are deemed to be outside your estate and can be passed on to beneficiaries without any IHT liability. If you pass away before the age of 75, your beneficiaries will not have to pay any tax at all. If you pass away over the age of 75, your beneficiaries should only be liable to pay at their own marginal rate of income tax. Strategic nomination of beneficiaries can optimise tax planning in such scenarios.
Finally, a reduced rate of IHT at 36% will be applied to the remainder of a taxable estate if the deceased leaves over 10% of the net value of their estate to charity in their will. This also applies if they were gifts made during lifetime.
To minimise the impact of IHT and secure your legacy for future generations, it is essential to undertake strategic planning that is tailored to your circumstances so that you make the most effective use of the following:
- IHT nil-rate band and residence nil-rate band
- Spouse or civil partner exemption via outright gifts or gifts into trust
- Potentially exempt transfers (PETs)
- Annual gift allowance
- Business Property Relief (BPR) and Agricultural Property Relief (APR)
- Pensions
- Charitable giving
- Tax-efficient use of flexible trusts that enable you to protect children.
We would strongly encourage that you seek advice on how to protect your property and ensure that it provides long-term benefits for your family. Drawing upon our extensive experience in IHT planning for our global client base, Sovereign Corporate & Trustee Services (SCATS) is well-equipped to provide essential guidance in this area.
