Why is Inheritance Tax Planning Important?
The many exemptions available make sound inheritance tax planning essential to minimise tax liability. Failure to do so would result in a significant portion of the assets painstakingly built-up over the years or passed on from generations to generations falling into the hands of the government, with the heirs unable to benefit fully from such assets.
What is Inheritance Tax Liability?
Inheritance Tax is tax on the estate of a deceased person.
The government fixes a threshold value, and if the value of the deceased’s estate adds up to more than this threshold limit, the estate attracts inheritance tax at 40 percent of the amount over the threshold value. The threshold for 2011-2012 is £325,000
Who is liable to pay Inheritance tax?
Inheritance tax is payable within six months of death of the estate owner. The liability of payment falls on the executor of the will or the personal representative of the estate owner. When the estate owner dies without a will, the administrator becomes liable to pay the tax. When assets transfer to a trust, the person making the transfer or the “settler” is liable to pay the tax.
The tax payable is due from the dead person’s estates. Since it is not always possible to convert the estate to cash form within the six-month deadline, the executor, administrator or settler often pay from their own pocket and recover the expenses from the estate later.
In normal circumstances the beneficiaries or recipients of the estate do not become liable to pay inheritance tax. However, if the executor or the trustees cannot pay Inheritance Tax, the beneficiaries who receive any share of the estate or the person who received a gift from an estate-holder who died within seven years of making the gift becomes liable to pay the tax. The tricky issue here is that if the total value of the estate is above the threshold value, the individual recipient of a gift becomes liable to pay inheritance tax even if the gift in his or her possession is below the threshold limit.
Joint ownership of estates with total value above the threshold limit may make the surviving partner liable to pay inheritance tax on the share of the deceased partner.
How to Save Inheritance Tax
Estates that pass on to spouses or civil partners are exempt from inheritance tax, even if the value of such estates are higher than the threshold limits. Estates that pass on to anyone else, including brothers, sisters, children and grandchildren attract inheritance tax. The law nevertheless allows various exemptions on inheritance tax.
Proper awareness of such exemptions and sound inheritance tax planning makes it possible to reduce significantly or even avoid having to pay inheritance tax.
Apart from transferring assets to a spouse, the ways to save on inheritance tax are by making gifts, making donations, making certain pension contributions, and selecting the right type of assets such as business or agriculture assets. Some other methods such as changing domicile also work.
How to Save on Inheritance Tax by Making Gifts
In normal course, if a person makes a gift to anyone and survives for seven years from the date of making such a gift, the value of the gift is exempt from inheritance tax. This holds true regardless of the type, nature or value of the asset.
Gifts made to a spouse or civil partner with permanent residence in the UK, during the estate-owner’s lifetime or through will are fully exempt from inheritance tax. Gifts to an unmarried partner, or a non-registered civil partner are however not exempt and attract inheritance tax.
Conditional gifts or gifts with “contractual obligations” that allow the estate-owner to continue benefiting from the estate render the exception void, and in such cases, the gift still becomes liable for Inheritance Tax even if the estate owner lives beyond seven years after making the gift. For instance, if a house owner bestows his house upon his son but still resides in the same house without paying rent, the house still attracts inheritance tax.
Inheritance tax laws also contain certain additional provisions that exempt gifts from inheritance tax even if the estate owner dies within seven years from making the gift. Such gifts are:
- An individual making a gift up to £3,000 each year, either as a single gift or as several gifts. The law also allows carry-over of any unused allowance for one year. A person not making a gift in a year may effectively make an inheritance tax-free gift of £6,000 the next year
- Unlimited small gifts of £250 to any number of individuals
- Gifts for wedding or civil partnership ceremonies. Parents may provide tax-free worth £5,000. Grandparents and great grandparents may make gifts worth £2,500, and others may make gifts worth £1,000
How to Save Inheritance Tax by Making Pension Contributions
Pensions offer another way to save on Inheritance Tax.
Transfers into a qualifying pension scheme, including some non-UK schemes are exempt from inheritance tax. Any left-over funds in a pension scheme, paid to any dependent as pension benefits, or to a charity do not attract inheritance tax.
However, all other cases of left-over funds, including funds paid as lump-sum death benefit attract Inheritance Tax.
How to Save on Inheritance Tax by Making Donations
Another option to avoid inheritance tax is by donating to charities. The law exempts from inheritance tax any gifts made to “qualifying charities” during the estate owner’s lifetime or in the will. All registered European Union charities may pass the test of “qualifying charity.”
Donations to some national institutions such as museums, universities and the National Trust, or contributions to any UK political party that has at least two members elected to the House of Commons or has one elected member with the party having received at least 150,000 votes also remain exempt from inheritance tax.
How to Avoid Inheritance Tax by Choosing the Nature of Assets
The nature or type of the estate can alter inheritance tax liability.
Tax laws allow relief from inheritance tax if the estate is a farm, woodland or National Heritage property. The law also allows relief for estate held as a business.
What Holdings Qualify for Agricultural Relief?
The following agricultural holdings do not attract inheritance tax, provided the estate owner holds such assets for a minimum of two years before death
- Agricultural land or pasture. Farmhouses, cottages or buildings in such lands also qualify provided their size and nature matches the farming activity
- Buildings used for intensive rearing of livestock or fish
- Stud farms for breeding and rearing horses
- Growing crops transferred with the land
- Short-rotation coppice, or trees planted and harvested at least every ten years
- Land not farmed actively to preserve the countryside and habitat for wild animals and birds under the Habitat Scheme
- Value of timber in woodlands, unless the timber is sold and exemption claimed under Business relief
Farm equipment and machinery such as tractors, derelict buildings, harvested crops and livestock do not qualify for inheritance tax exemption. The land value of woodlands also does not qualify for relief.
What Holdings Qualify for Business Relief?
The following business holdings do not attract inheritance tax
- Shares that give the shareholder control of the company. Shares that provide the estate owner with more than 50 percent of the voting rights provide 50 percent relief from inheritance tax
- Shares in a trading company or group that does not have excess cash or investment, provided the share is with the estate owner for a minimum of two years
- Land, buildings, plant or machinery used for the business during the last two years before the business was passed on, or held in a trust from which the estate owner can benefit
Estate owners may gift the business property or assets that qualify for business relief when alive without putting the business relief at risk, provided the recipient continues with the business until the original estate owner’s death, or until seven years have passed, whichever is earlier.
How Changing Domicile Helps in Inheritance Tax Planning
UK Inheritance Tax it based on domicile rather than residence. A permanent move to a new country with no intention of returning to live in the UK allows saving on inheritance tax.
This is difficult, but by no means impossible. Success depends on developing a thorough affidavit that documents the intentions, facts, and reasoning to support the new domicile claim. After having taken a new domicile, wrapping UK assets into a suitable offshore structure provides an exemption. The UK has Double Tax Treaties relating to inheritance taxes with France, India and a few other countries, which may help the estate-owner to select the best possible option.