Jonathan discusses the main inheritance tax exemptions and reliefs
In England and Wales, when someone dies there is a possibility that some of their estate will be subject to inheritance tax. The law governing this area is set out in the Inheritance Act 1984.
There is a lower limit to which inheritance tax can be applied. This is known as the ‘Nil Rate Band’. Since 6 April 2009 the nil rate band has been fixed at £325,000. This means that if the gross value of an estate, including the cumulative total of any lifetime gifts made in the preceding 7 years, is less than £325,000 there will not be any inheritance tax to pay. It is still important to note, however, that every pound over this limit will, subject to any reliefs and exemptions, be taxed at 40%.
As house prices continues to rise, more and more estates are passing the £325,000 threshold and many people are now looking into ways to avoid inheritance tax. Whilst some of these methods are controversial and may involve complex mechanisms, there are a number of simpler, and legitimate, ways of reducing your inheritance tax bill.
1. Marriage / civil partnership
One obvious way is through marriage or civil partnership. Section 18 of the Inheritance Act 1984 provides that a transfer to a spouse or civil partner will be exempt from tax.
An addition tax benefit available to married couples and civil partners is the “transferrable nil rate band”. When a spouse dies, the surviving spouse inherits their remaining nil rate band, calculated as a percentage to take account of any potential changes to the nil rate band limit. For example, if a husband died with 50% of his nil rate band unused, the wife would then have that 50% in addition to her own nil rate band.
2. Gifts and transfers of property
A further method which can be used to reduce inheritance tax is the transfer of money and/or property as a gift or into a trust.
The Inheritance Act 1984 provides for certain exemptions allowing money or gifts to be made without incurring inheritance tax. These include gifts to charity, gifts not exceeding £250 to a single individual in one year, an annual transfer of £3,000 to a single individual or £5,000 as a gift of marriage from parent to child, to name a few.
The pitfalls in many situations involve gifts of property. In order to give a gift of property, the original owner of the property must ensure that they give up any benefit or entitlement to it. The main example is a gift of your main residence. In order to demonstrate that you do not benefit or remain entitled to the property, you would need to be paying rent to the new owner or move out completely. If you do not show that you are no longer receiving a benefit, the property may still be considered part of your estate for inheritance tax purposes, known as a “gift with reservation of benefit”.
However, if a person dies less than 3 years after they transfer the gift, the full 40% tax will still apply to anything over the nil rate band. This, however, will gradually reduce from 40% after three years on an annual sliding scale eventually reaching 0% after 7 years. This is known as “taper relief”. Full information regarding this can be found here.
3. Use of exemptions and reliefs
There are a number of exemptions and reliefs which may apply.
For instance, many businesses and associated assets are eligible for what is known as business property relief which can reduce inheritance tax by up to either 50% or 100%. There are strict rules which apply to business property relief such as that the business asset will usually need to have been owned for at least two years prior to death or transfer.
Another example of a relief which is especially useful in the agricultural and farming sectors, particularly with the rise in land values, is agricultural property relief. Again, there are strict rules which apply to qualify for this relief so the key is to seek advice early on.
One often overlooked exemption is that gifts to charities are usually free from inheritance tax. Further, broadly speaking, where a person donates 10% or more of their estate to charity, the rate of inheritance tax on the taxable estate thereafter is reduced from 40% to 36%.
These are, of course, just a number of the exemptions and reliefs available but demonstrate that, with the right planning, it is possible to increase the amount that you pass on to your loved ones.