Coronavirus has presented an unwelcome reminder of our own mortality and left many people scrambling to make sure their financial affairs are in order, including their inheritance tax (IHT) liability.
Everyone has an IHT allowance of £325,000, known as the nil-rate band. Any assets other than the family home over the £325,000 threshold are subject to IHT of 40 per cent. The value of the family home can be offset against the residence nil-rate band, which for the 2020-21 tax year is £175,000 per person, if it is left to direct descendants.
Transfers between married couples and civil partners are not usually subject to IHT, so if the first partner to die leaves their estate to the other, no tax will be payable. And the remaining partner can use the deceased partner's nil-rate band when they die, effectively doubling the threshold for this to £650,000 and the residence nil-rate band to £350,000.
But if you have assets over and above this you will need to look at other ways of passing them tax-efficiently to your heirs.
Passing on assets
Making a gift to your family and friends can be a good way to reduce the value of your estate for IHT purposes and benefit your loved ones immediately. You can give away £3,000-worth of gifts each tax year without them being added to the value of your estate. And if you don't use this annual exemption in a given tax year you can carry it forward to the next year, but only for one year.
If you die after seven years of gifting an asset of any value no IHT is payable on it. But if you die within three years of making a gift and have used up your £3,000 annual exemption, you pay IHT of 40 per cent, if it is not covered by your IHT allowance. Gifts made between three and seven years before your death are taxed on a sliding scale known as taper relief, if they do not fall within your IHT allowance.
When making a gift, you have to pay capital gains tax (CGT) on any profits you have made on the asset in excess of your annual CGT allowance, which is £12,300 for the 2020-21 tax year. As values of equity portfolios have dropped substantially now could be a good time to make a gift because your CGT liability is likely to be lower than it would have been at the start of the year. If you die within seven years and IHT is payable, tax is charged on the value of the asset at the point of gifting. So if the asset goes up in value after you have gifted it, the recipient effectively benefits from a lower tax rate.
If when you die the value of the gift is lower than the time at which it was given, the recipient can claim falling value relief. This means that IHT is charged according to the new lower value.
“Now might be a more appropriate time than ever [for gifting],” says Jo Douglas, assistant director at Brewin Dolphin. “If you are gifting stocks and shares, you could take advantage of current market prices and make the gift now rather than in a year’s time when the markets might have recovered and the gift is larger.”
If you have made gains on stocks that you have held for a long time, now might be a good time to offset gains against losses, and the rest against your annual CGT allowance.
“With the market [having fallen] there are lots of opportunities to manage CGT liabilities that you would otherwise incur on gifts,” says Julia Rosenbloom, partner in private client tax services at Smith & Williamson. For example, she says that if part of your portfolio was acquired six months ago at the height of the market and its value has now fallen 30 per cent, you could crystallise the capital losses by offsetting them against gains on assets that you plan to gift.
If you incur CGT on the gifted assets and die within three years of giving them, they could also incur IHT. And this might amount to more than what you and your heirs would have paid if you had kept the assets within your estate. Jamal Khan, senior tax partner at Churchill Tax Advisers, says that his clients have been making fewer gifts for this reason.
If you want to pass on assets but don’t want the beneficiaries to have control over them at that point, you could put them into a trust. If the disposal incurs CGT when being transferred to a trust you can defer it.
Trusts can be set up for children, with parents as the trustees and children as the beneficiaries. Ian Dyall, head of estate planning at Tilney Group, says that as the trust does not form part of its beneficiaries’ estate, in cases where they are on state benefits, for example because they are disabled, they can continue to receive them. You can put £325,000 per person into a trust every seven years without incurring IHT, as per your nil-rate band, but any assets over this value will trigger tax of 20 per cent.
People with large estates could set up a family investment company as this does not incur IHT. These can have different share classes so that, for example, the parents are the trustees and make the decisions on the assets and the children are beneficiaries. Ms Rosenbloom says family investment companies can be a tax-efficient way to hold stocks and shares. If these are held outside a tax-efficient wrapper such as an individual savings account (Isa) or self invested personal pension (Sipp), they will incur tax on any dividends paid over and above the annual dividend allowance of £2,000. But if you hold these in a family investment company you will generally pay no tax on that income, as long as you reinvest the dividends and don’t draw them out of the company. If you do this you will pay tax on them.
Rebates
If you have paid IHT in the past year on inherited share portfolios or properties, and their value has plummeted meaning that you sold them at a loss, you can apply for a tax rebate. Under current tax rules, executors can apply for IHT refunds on losses made on the sale of inherited securities within 12 months of an individual’s death. The relief applies to listed shares, gilts (UK government bonds) and open-ended funds – but not unquoted or Aim shares.
To make a claim you need to fill out an IHT35 form, which you can find at: www.gov.uk/government/publications/inheritance-tax-claim-for-relief-loss-on-sale-of-shares-iht35.
You can also claim a rebate on property if you sell it for a lower value than its probate value within four years of the death. “The difference could be huge” says Ms Douglas. To make a claim you need to fill out an IHT38 form, which you can get at: www.gov.uk/government/publications/inheritance-tax-claim-for-relief-loss-on-sale-of-land-iht38.
In the 2018-19 tax year more than 4,500 estates claimed IHT loss relief and the numbers may increase this year as asset prices have faced sharp declines. Rupert Wilkinson, partner at Wilsons Solicitors says: “There are going to be some very large sums at stake and the process of making a claim for loss relief is relatively straightforward.”
Accuracy of wills
If you have assets to pass on, you should make sure that you have at least a simple will to help pass them on in an orderly way when you die. If you have no will, intestacy rules apply whereby a surviving partner can keep up to £270,000, and any surplus is divided among children and the spouse, with IHT paid on assets over the nil-rate band.
You also need to make sure that your will says what you intend. “What people think their will says and what it actually says can be quite different,” says Mr Dyall.
For example, the will has to be accurate to make proper use of the residence nil-rate band when passing on a property to a direct descendant. Together with the annual IHT allowance, it allows each person an IHT allowance of £500,000, where the assets include a property, to make it easier to pass on a family home to direct descendants.
But the residence nil-rate band tapers off if your estate is worth more than £2m, at a withdrawal rate of £1 for every £2 over this threshold. Your estate is based on the value at death, so you can gift assets at any point in advance to reduce the value of it to below this level, if appropriate. “There is a lot of confusion around the £2m taper threshold,” says Jess Franks, tax specialist at Octopus Investments. “The residence nil-rate band taper threshold at £2m is a test that is only run on the day you pass away, so someone with a big estate can do later-stage planning [without worrying about the seven-year threshold].”
Terry Jordan, senior adviser at tax specialists BKL, says that some of his clients have assets worth under £2m, but when combined with the value of their property are worth over £2m. So by leaving a portion of the value of their house to children when the first of the couple dies, they can lock in the full value of the residence nil-rate band.
If you have made a gift within seven years of your death the recipient usually pays IHT due on that gift. If you have not taken out life insurance to cover any IHT due, you could state in your will how the tax is to be paid. “If you can afford it, you can make a provision that the tax on lifetime gifts comes out of your estate," says Ann Cory, senior associate at Wilsons Solicitors. "Then the executors are clear that they can use the estate to pay the tax liability and if, for instance, the recipient cannot afford to pay the tax, you avoid any confusion about who should be paying it and where the funds to pay the IHT come from.”
Taking out life insurance to cover IHT is sensible if you can afford to do this, for example, because you are quite young, adds Mr Wilkinson. However, if you are elderly it might be very expensive to do this.
