‘I’m an inheritance tax expert – here are important things to know about gifts and trusts’
Complex inheritance tax rules could be the reason more estates are being dragged into the net, an expert has said.
HMRC amassed a staggering £700million in inheritance tax receipts in April alone, marking an increase of a staggering £85million compared to the same period before.
Following wealth gifting rules is an important step to minimise future inheritance tax liabilities, but there are some crucial pitfalls to watch out for.
Matt Parr, partner and inheritance tax planning specialist at Mayo Wynne Baxter, said: “Inheritance tax remains a very touchy subject amongst many clients and given the rate stands at 40 percent, it is often seen as unfair that assets can’t pass as freely between generations as many would like.”
That said, he noted: “Only approximately four percent of estates are liable to inheritance tax.”
What is Inheritance Tax?
Inheritance Tax is a tax on the estate (property, money and possessions) of someone who’s died.
There’s usually no Inheritance Tax to pay if either:
• The value of your estate is below the £325,000 threshold you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club
• The standard Inheritance Tax rate is 40%. It’s only charged on the part of your estate that’s above the threshold.
For example:
Your estate is worth £500,000 and your tax-free threshold is £325,000. The Inheritance Tax charged will be 40% of £175,000 (£500,000 minus £325,000).
Who pays Inheritance Tax?
• Funds from an estate are used to pay Inheritance Tax to HM Revenue and Customs (HMRC). This is done by the person dealing with the estate (called the ‘executor’, if there’s a will)
• Beneficiaries generally don’t pay tax on things they inherit. They may have related taxes to pay, for example, if they get rental income from a house left to them in a will.
The specialist said, that, while it’s not always possible to avoid an estate paying any inheritance tax, “it is often possible” to reduce the amount payable by taking advice early on.
Additionally, he said people should make their executors aware of any reliefs or exemptions that they may be able to claim on their death.
Mr Parr added: “The rise in inheritance tax receipts may simply be because of the complexity of the rules and individuals not seeking that advice to take advantage of the allowances or reliefs, rather than more estates falling within the remit of having to pay inheritance tax. The sooner you start planning the better.”
Inheritance tax gifting rules
Explaining the basic rules, Mr Parr said: “You can make a gift of cash or belongings or any value to individuals at any point, but you need to survive a period of seven years from the date of the specific gift before the value of it drops out of your estate for inheritance tax purposes.”
Once gifted, people cannot continue to derive a benefit from the asset – and they must make sure they aren’t. Mr Parr explained: “If you gift a painting, you shouldn’t continue to have this hanging in your dining room, or if you gift, property you cannot continue to live in it rent-free or earn the rental income from it.”
If an individual continues to derive a benefit from a gifted asset, the gift may be unsuccessful in reducing inheritance tax. This is because it would be considered a “gift with reservation of benefit,” and HMRC would treat it as though the asset had not truly been given away.
Inheritance tax-free gifts
Everyone is able to gift up to £3,000 per tax year without needing to survive seven years.
Additionally, Mr Parr noted: “A couple in a marriage or civil partnership can gift up to £6,000 between them, or perhaps £12,000 between, them if they hadn’t utilised their £3,000 allowance in the preceding tax year.”
It is also possible to gift “excess income” over and above the £3,000 allowance. Mr Parr explained: “Provided you make these types of gifts regularly or demonstrate the intention to do so and provided you can demonstrate on each occasion that the funds are not needed to maintain your standard of living, the value of these gifts is not limited as each individual’s income and needs are different.”
If people do make these sorts of gifts, Mr Parr said: “It is essential you keep accurate contemporaneous records of the same.”
Whilst people are not under a duty to report these transactions to HMRC at the time of making them, Mr Parr said: “Your executors will be expected to provide HMRC with quite detailed information about your income and outgoings, and gifts made on each occasion to be able to claim these reliefs.”
Mr Parr added: “Remember, on the whole, it isn’t the individual making the gifts that are responsible for reporting the same to HMRC, instead this burden will fall on their executors named in their will.
“If you want to make their life as simple as possible when it comes to dealing with your estate administration, being as transparent and accurate with your records of gifting will be essential. The executors may be held personally responsible for reporting inaccurate information to HMRC even if unwittingly.”
What to watch out for when gifting your estate
Mr Parr warned that if an individual gifts property or other assets that have increased in value, such as a property, there may be an “immediate capital gains tax liability”.
This liability can arise as a consequence of gifting the asset, even if it has not been sold or the gain has not been realised.
Mr Parr said: “It’s important, therefore, to ensure you have accurate values and have a cash reserve to meet any capital gains tax liability arising immediately.
“It is possible to ‘postpone’ any immediate liability to capital gains tax by instead gifting assets, such as property or shares that have increased in value, into a trust instead of to an individual and applying for holdover relief which in effect holds the gain over into the hands of the trustees.”
Mr Parr explained that individuals are generally limited to gifting assets worth up to £325,000 into a trust every seven years to avoid an immediate inheritance tax charge.
If the value exceeds £325,000, the excess amount is subject to a 20 percent inheritance tax rate, rather than the death rate of 40 percent. Consequently, he noted that options for gifting to trusts are often “limited”.
Mr Parr continued: “If you make a gift to an individual and die within seven years of the date of the gift, the value of the gift at the date the gift was made is deducted from your available nil rate band of £325,000 and as such your estate may incur more inheritance tax.
“If, however, the cumulative value of all the gifts made in the seven years before your death exceeds £325,000 then, strictly speaking, it is the recipients of the gifts that have exceeded the £325,000 that bear the IHT on the value of their respective gifts.”
To minimise this risk, Mr Parr suggested ensuring gift recipients will be in a position to pay this liability, should they be required to do so.
He added: “It is possible to make provision in your will for your estate to have to bear the tax arising on lifetime gifts, but the rules can be complex.”
Mr Parr added that if the cumulative value of the gifts exceeds £325,000 and tax is due, the benefits of making a lifetime gift will begin to take effect after three years. From that point, the tax liability is reduced by 20 percent each year, a process known as taper relief.
Mr Parr said: “So regardless of whether you feel you will survive the full seven years, it might still be worth giving away assets now.
“I always advise clients that they need to look after their own needs first and foremost. They should always consider how their future needs might change and whether they can afford to do all the things they were otherwise planning to do in retirement if they give significant gifts away earlier in life.”