Inheritance Tax - the problem that won't go away

The Government claims that only 6% of estates are liable for inheritance tax (IHT). That claim is currently factually correct. However, the number of families that have a liability to inheritance tax is much greater.

The 2007 Pre Budget Report introduced changes that seemed to arise as a result of the political clamor for reform. Did the new Chancellor go for enough? While the changes have removed inheritance tax from the political landscape, inheritance tax planning should not be removed from the agenda of those who have wealth in excess of £300,000. The new rules may reduce the liability for some, but for many this 'death tax' remains.

The 2007 Pre Budget Report announced changes intended to avoid the benefit of the £300,000 nil rate band allowance being lost on first death. It is now possible to transfer unused nil-rate band allowances between spouses or civil partners.

The amount of the nil rate-band potentially available for transfer will be based on the proportion of the nil-rate band unused when the first spouse or civil partner died. If on the first death the chargeable estate is £150,000 and the nil-rate band is £300,000, then 50% of the original nil-rate band is unused. If the nil rate band when the surviving spouse dies is £350,000, then that would be increased by 50% to £525,000.

Does this change eliminate the need for inheritance tax planning? No! While the change is welcome inheritance tax remains a significant 'pregnant' liability for many and minimising this tax liability remains a key area where we can assist with your planning.

Although IHT is charged at 40%, there are a number of reliefs available - perhaps most importantly relief on business and agricultural property, which effectively takes most of such property outside the IHT net. There is also scope to make a significant reduction in the IHT liability on your estate by following a programme of lifetime gifts - gifts made while you can see the benefit they bring to your family members, and which escape IHT if you survive seven years. Even trusts, despite new rules, offer some IHT savings (and are often used not to save tax, but to protect family wealth).

The family home

However, there is one major cause for concern for more and more people, for whom the one asset which has probably increased in value by a greater percentage than any other is the family home. As the value advances, so does the 'embedded' IHT.

Faced with the potential IHT on the family home, some people have chosen to 'downsize' - sell the home, buy a smaller, lower value property, and release cash which can then be used to fund living expenses in retirement and lifetime gifts. Some have sold their home in the UK and retired abroad while others have raised loans on their homes in order to reduce the net asset value of the home.

For those families with a valuable property which the children may seek to retain, there is the issue of funding the IHT payable on the death of the parents. The executors need to raise the money to pay the tax due without selling the house - and that can mean selling other assets.

What can you do about IHT? Realistically, your options might be limited, but talk to us. We have already mentioned some possibilities. Equity release may not be for everyone, but in some cases it could help. A nil-rate band trust might help - the surviving spouse could occupy the house with the adult child, as joint owners, with no IHT problems following the death, and the tax saving could be as much as £120,000 - a bit more than the average IHT paid on estates which, according to Government statistics, is just over £100,000.

Although there is scope for deathbed planning to reduce IHT, it is worth spending time now facing up to the issues, and considering the amount of tax at stake, and the possible means to reduce it.

IHT traps:

Business assets

A gift of a qualifying business asset is usually covered by a 100% inheritance tax relief. Gifts made within seven years of death are added back into your estate, for the purpose of calculating IHT on your death. So if you make a gift of business property and die three years later, there will be no tax to pay? Sadly, the answer is a 'maybe'.

In this case, the asset that was gifted was qualifying business property, and therefore covered by the 100% relief. If the value that asset represented is still business property at the time of your death, it will continue to score for the 100% relief. It does not even need to be the same property, just so long as it meets the qualifications.

But what if the donee had sold the asset and invested the proceeds in something else - something not qualifying for business property relief? Unfortunately, the value of the gift is added back, but without the relief - so if the gift was made within three years of death, it is taxable in full.

Discounts

You've added the gift back into your estate, but gifts made more than three but less than seven years before death qualify for a discount. The discount, though, is not applied to the gift but to the tax on the gift and the nil-rate band is first applied, by law, to the lifetime gifts in the seven years before death. So a discount of up to 80% is worth nothing, if the gifts affected are less than £300,000.