Death and taxes are inevitable, but with careful planning and forethought, you can be confident that your loved ones will be taken care of without hefty taxation bills taking a chunk out of their inheritance.
IHT, or inheritance tax, can be a major concern for many people, but there are ways to ensure that you can pass on assets to the next generation in a tax-efficient manner. Here we examine the risks posed by IHT, and the key considerations that you need to take into account when estate planning.
Estate Planning
Estate planning ensures that your loved ones can avoid protracted disputes and financial distress upon your passing. Taking control of the division of assets with a well-crafted plan will provide peace of mind, easing any burden on those you care about most. Establishing an estate preservation strategy is essential to smart long-term financial management regardless of your net worth.
An estate plan may also help to avoid IHT costs and ensure that assets are passed in an orderly manner. Such a plan should outline how you want all of your assets and possessions transferred following your passing, putting in place the necessary paperwork to guarantee that your assets are transferred in accordance with your intentions.
How does Inheritance Tax work?
Irrespective of the size of your estate, it may still be subject to IHT after you pass away.
IHT will not be due on any portion of your estate that is left to your spouse or civil partner. However, if your spouse or legal partner lives outside of the UK, you can only give them a maximum of £325,000 before IHT may have to be paid. There are no automatic rights for unmarried partners under IHT regulations, regardless of how long you have been together.
When a person passes away, IHT is due on all items of value, including:
- Your house
- Jewellery Investments and Savings
- Artwork
- Automobiles
- Any additional physical property or land, even if located abroad
If your estate is left to a beneficiary who is not exempt, IHT will be due on the portion of the estate that exceeds the nil-rate level. The price cap currently stands at £325,000.
Every person is entitled to a nil-rate band, which allows them to leave a portion of their estate to a beneficiary who is not exempt from paying IHT up to the value of the nil-rate threshold.
If you are widowed and your deceased spouse did not use all of their nil-rate band, the nil-rate band that will apply to you when you pass away can be increased by the portion that was left over after their death, provided that your executors make the appropriate affirmations within two years of your passing.
Gifts made during your lifetime that are not exempt transfers must also be included in order to determine the overall amount of IHT that will be owed upon your death. When the value of the portion of your estate left to non-exempt beneficiaries and the total amount of non-exempt gifts made within seven years of your death surpass the nil-rate threshold, IHT will be due at a rate of 40% on the portion that exceeds the threshold.
If the estate is entitled to a lower rate as a result of a charitable bequest, this decreases to 36%. In some cases, the lifetime donations themselves will also be subject to IHT; however, taper relief, which lowers the amount of inheritance tax, may apply to gifts made between three and seven years before death.
Taper relief is calculated on a sliding scale against the tax burden you would otherwise incur, rather than the value of the gift itself. A gift’s worth is determined at the moment it is gifted, not by what it is deemed to be worth at the time of death.
You are allowed to give a few small presents each year without incurring an IHT duty, according to HM Revenue & Customs (HMRC). Each person receives their own allowance, so if both spouses or registered civil partners utilise theirs, the total might be doubled.
You can also give larger gifts, but these are referred to as “Potentially Exempt Transfers” (PET), and if you pass away within seven years of making them, you might have to pay IHT on their value. Any other gifts you make during your lifetime that are not PETs will be subject to inheritance tax right away.
It is possible to gift cash tax-efficiently as a PET because it is not a ‘chargeable asset’ for the purpose of capital gains tax (CGT) purposes. However, there are very specific rules regarding this, and it is advisable to obtain legal guidance before committing to such an action.
Currently, HMRC allows the following types of exempt cash transfers:
- Up to £3,000 each year as either one or several gifts.
- Gifts of up to £250 to any number of other people (those receiving all or part of the £3,000 cannot be given an additional £250)
- You can gift your child £5,000 if getting married or entering into a civil partnership, or £2,500 for a grandchild.
- Charitable, political, or educational donations to bodies recognised by HMRC.
- Spouses (or ex-spouses), elderly or dependent relatives, and children under 18 or enrolled in full-time education may get maintenance payments.
- Gifts to small businesses, sole trader enterprises, or partnerships, and shares in companies listed on the smaller, more risky stock exchange.
Capital Gains Tax
Any non-cash gift (aside from cars or homes) could be liable for Capital Gains Tax (CGT).
Essentially, Capital Gains Tax is due on any profits realised when you sell an item that has appreciated in value. For instance, if you bought something for £1,000 and were fortunate enough to sell it for £3,000, you would be taxed on your gain using this levy rather than the proceeds from the sale. Before they reach a certain threshold (£12,300 in 2022-23), those profits will be subject to taxation.
However, you can reduce your taxable gains if you report losses to HMRC (also known as allowable losses). However, keep in mind that you cannot deduct losses when giving property to family members unless you make up the difference with a gain from the same person. This law applies to presents made to “connected people,” which are defined as direct family members, descendants, or business partners.
Gifting property can increase the tax-free threshold to £500,000 for estates worth less than two million, which is an efficient approach to lower the tax burden on your estate. In addition, capital gains on gifts of property will be taxed at favourable rates, with a £12,300 allowance for individuals and a £6,150 exemption for trusts.
Gifting chattels
Physical or ‘mobile’ assets are referred to as ‘chattels’, of which there are two different sorts: wasting chattels or cheap chattels. A wasting chattel is an item with a predictable usable life of under 50 years, such as a racehorse, whereas a cheap chattel is an object with a lifespan of more than 50 years; for example, an antique.
The issue with gifting chattels, of course, is CGT. With cheap chattels, in particular, there are specific rules regarding how CGT is calculated.
- The asset will be exempt from CGT if the market value and acquisition cost are both below £6,000;
- If both market value and acquisition cost exceed £6,000, normal CGT rules will apply.
- Where either market value or the original acquisition cost exceeds £6,000, the gain or loss is limited via taper relief.
- The aforementioned guidelines will not apply when two or more chattels that are part of a set are gifted to an individual; instead, regular CGT guidelines will be followed. This is problematic when items that form a ‘set’ have been gifted several years apart.
If you’re considering gifting assets that have lost value or are likely to, consider the fact that any capital losses will be restricted and can only be offset against future gains arising on disposals to the same person. For this reason, it may make more financial sense to sell off your asset and gift cash instead; thereby allowing for unrestricted access should a loss relief situation arise in later years.
Wasting chattels, however, are exempt from CGT and can typically be gifted without incurring a tax penalty. This rule has a few exceptions, such as assets for which capital allowances have been claimed.
Aside from wasting chattels, assets such as cars, stocks and shares held in an ISA, venture capital trust investments, EIS/SEIS eligible shares of unquoted trading companies, meaningful social enterprise investments, and gilts issued by the UK government are all exempt from CGT – meaning they can be gifted without incurring a tax liability straight away.
If the donor lives for seven years after the gift was made, it would be considered a PET under IHT law and would not result in taxation.
Surplus Income
For those looking to reduce the size of their estate, IHT relief offers a tax-efficient way by exempting gifts made from surplus income without making them wait for the standard seven-year period expected of normal cash gifts. There’s no limit on how much can be given in this way as long as it does not surpass the donor’s resources, and it has no impact on their ongoing living standards.
To qualify for this relief, donors need to ensure that their post-gift income is enough to sustain their normal lifestyle. Habitual gifts are key – such as via a standing order or recurring payments like school fees and life policies – while one-off donations or those made solely for special purposes cannot be considered eligible.
Anti-avoidance
Anti-avoidance rules are designed to prevent donors from benefitting from any assets that they once owned, stopping them from continuing to reap the rewards of ownership whilst reducing their estates for tax purposes.
Under anti-avoidance guidance, annual income tax charges can arise under the ’pre-owned asset tax’ rules, if, for example, it can be proven that the donor is retaining any perceived benefits. This could be as minor as taking a holiday in a boat or caravan now in someone else’s legal ownership or displaying a piece of valuable artwork in your home that you had previously given away.
It also prevents individuals from utilising a child’s tax-free allowances by proxy, making sure that any income arising from any asset gifted to a minor is assessed for income tax on the parent if proceeds exceed £100 in a tax year.
Gifting personal possessions and funds can be a great way to lessen one’s estate for IHT, however, it must be done with proper consideration of its taxation implications. To make sure that the gift is both advantageous tax-wise as well as free from unexpected costs, givers should take care not to benefit in any way themselves nor assist anyone else who’ll gain an advantage.
Before making any decisions, we advise consulting with a specialist for tax and legal advice regarding specific facts.
Please get in touch with our private wealth team‘s expert staff if you have any questions about any of the issues highlighted here for unbiased, confidential guidance.
