There are some common misunderstandings about Inheritance Tax.
The first Conservative Budget for almost 20 years confirmed plans to introduce a new main residence nil-rate band of £100,000 from April 2017, increasing each year, up to £175,000 in 2020.
The move will come as a relief to a good many individuals. But IHT remains a threat to many estates and it is a tax about which there remain many misconceptions.
Myth one: There is only one tax rate for IHT – 40%
Actually, there are three rates: 40%, 36% and 0%. The 0% rate, or ‘nil rate’ (which is different to an exemption), applies up to £325,000 per person, a level which the government has frozen until April 2021. IHT is a cumulative tax, so all gifts made in the seven calendar years preceding an event (normally death) count towards this total.
Once you breach that ‘nil-rate band’, you will pay 40% on the remainder.
A gift will only count towards the donor’s ‘cumulation’ for seven years, but it could remain relevant if you make subsequent gifts. ‘Taper relief’, designed to reduce an IHT liability, is applied chronologically to gifts made during the seven-year period immediately before death.
But the Budget in 2011 added a new band. If the deceased leaves 10% or more of their estate to charity, then the tax rate is 36% above the nil-rate band (and after deductions for IHT exemptions and reliefs). The government introduced this to encourage charitable giving and to support the voluntary sector.
Myth two: IHT is only paid on death
Actually, IHT on some gifts must be paid while the donor is still alive. There are three types of gift for tax purposes. First, those that are exempt, where IHT will never be due. Next, those that are potentially exempt, where tax may arise where the donor dies within seven years – and where the cumulative value of such gifts, together with the value of the donor’s estate on death, exceed the donor’s nil-rate band.
Finally, there are gifts that are ‘chargeable’ or taxable. The most common form of chargeable gift arises when a discretionary trust is set up. The tax rate applicable to such gifts is 50% of the death rate and is immediately payable, though tax only becomes due once the total value of chargeable gifts made by the donor exceeds their nil-rate band. Gifts to bare trusts and disabled trusts are exempt.
Myth three: “In this world nothing can be said to be certain, except death and taxes”
Benjamin Franklin’s renowned quote was making the point that the new United States Constitution, however solid it looked, was not guaranteed to hold; not as certain as it is that one’s wealth will be taxed. However, in the case of IHT, it is generally only extreme wealth or, more likely, poor planning that makes payment inevitable.
From charitable and party political donations to gifts made to spouses and civil partners, there are many ways to save your heirs an IHT bill. There is an annual gifting exemption of £3,000 that can be carried forward if it wasn’t used in the previous tax year, providing the potential for a married couple to remove £12,000 from their joint estate immediately. In addition to gifts out of so-called ‘excess income’, there are more esoteric exemptions, such as gifts for maintenance of a dependant relative.
The availability of these exemptions and the suitability of their use will, of course, vary based on individual circumstances.
The level and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
Trusts are not regulated by the Financial Conduct Authority.