How to reduce your Inheritance Tax liability

One resented tax that can hinder how much of your hard-earned assets are passed to your children, friends and family is Inheritance Tax (IHT). The thought of paying IHT can leave you feeling irritated because it’s likely that some of your hard-earned assets cannot be passed to your loved ones without a huge chunk of it being taken by HM Revenue & Customs (HMRC). Here, we take a look at some of the ways you can reduce your IHT bill.

The IHT threshold is currently £325,000, and will remain at this figure until 2015. If you leave behind anything worth more than this, the tax will be charged at 40% on anything extra.

Generally speaking, if you are UK domiciled then you will be liable to IHT on all your assets, wherever they are in the world. If you are domiciled in another country, then you are only liable for IHT on your UK assets.

What is domicile?

You acquire your domicile at birth, and it is usually that of your father. So for example, if your father was UK domiciled but worked in Spain and you were born in Spain, your domicile would not be Spain, but the UK.

You can, however, be “deemed domiciled” in the UK for IHT purposes – if:

• You were domiciled in the UK within the three years immediately before a transfer of assets, or
• You were resident in the UK in at least 17 of the 20 tax years ending with the year in which you make a transfer.

So, you’ve added up all your assets, which include but is not limited to, properties, savings, investments, personal equity plans, ISAs, personal possessions and shares. Deduct any debts off your total and if what is left is more than £325,000 (or more than £650,000 for a married couple) then you will be liable for IHT. So how can you reduce the amount of tax you pay on this?

1. Get married

Anything you leave to your spouse is free of IHT. This is also true for those in Civil Partnerships. If you leave all your estate to your spouse or civil partners when you die,, your tax-free IHT allowance of £325,000 can be transferred to your spouse/civil partner meaning that they not only benefit from their own tax-free allowance, but yours as well. This means they can have a total tax-free allowance of £650,000.

Example:

Mr and Mrs Smith have assets worth £800,000 between them. Let’s say Mr Smith dies first, and leaves £200,000 to their children. The remaining £125,000 of his nil-rate allowance will pass on to Mrs Smith, leaving her with an IHT allowance of £450,000.

When she passes away, with assets of £600,000, she’ll owe 40% on everything above £450k, meaning £60,000 (40% of £150,000) will be payable in tax, leaving all the rest (£540,000) to the children.

It is important to note that unmarried couples do not have the same advantage when it comes to leaving assets to one another. If you own your home jointly but you are not married then your partner could be liable for a IHT bill just to continue living in the property.

2. Spend it

It’s your money and you can’t take it with you. Booking a trip around the world or a couple of nights in Dubai’s Burj Al Arab hotel might not be a bad idea after all.

3. Gifting

The simplest way of avoiding or reducing the IHT bill on your estate is by gifting it away while you are still alive. Your Annual Exemption for gifts is £3000, and you can carry forward any unused part of this to the following tax year.

Wedding gifts from parents can be up to £5,000 tax-free, £2,500 from grandparents and £1000 from anyone else. You can also make gifts of up to £250 a year to as many individuals as you like.

Gifts as part of your ‘normal expenditure’ are also exempt from tax provided they do not compromise your standard of living and come out of say, your current account rather than from savings or capital.

4. Life insurance

Another way to avoid this ‘death tax’ simply and efficiently is to buy life insurance which will pay out upon your death. As the premiums are not overly costly, life insurance is often the simplest way of ensuring your IHT bill is covered. You can write your life insurance policies ‘in trust’. This means that they will be excluded from your estate and therefore won’t add to its value, increasing the risk of IHT being due. Life insurance polices when placed ‘in trust’ also mean that they are paid to your beneficiaries quickly and efficiently. This means that on your death, the payout of the insurance can be used to pay the tax bill.

5. Tenants in Common

Often the biggest IHT burden comes with property. Most couples who own homes together are joint tenants, meaning they own the property together. However, becoming tenants in common means that each of you will own your share of the property separately. This means that you could leave your half of the property to someone else, thereby keeping the value of your estate down.

6. Donate to charity

Money given to charities and political parties are exempt from IHT. If you leave 10 per cent of the net value of your estate to a ‘qualifying’ charity, then any IHT that you are liable for on the rest of your estate will be charged at 36% instead of 40%. A ‘qualifying’ charity is one that is recognised by HMRC and will have an HMRC reference number.

7. Write a will

To avoid your assets being passed to people under the rules of intestacy, you need to write a will. This is the first step in reducing your IHT bill because you can control what goes where and to whom. As mentioned previously, anything left to your spouse is tax free, so it makes sense to leave as much as possible to them. Under the rules of intestacy, your spouse might not inherit as much as you’d like them to, thereby increasing the chances of IHT due. If you leave behind a spouse and children, under the intestacy rules, your spouse will get the first £250,000 and a ‘life interest’ in half of the rest.  The children will inherit the rest. So depending on the size of your estate, IHT could be due on what is passed to your children.

With a will in place, you can put part of your wealth into trust, or leave some of it to charity, thereby further reducing your IHT bill.

8. Business Property Relief

Your business interests and assets form part of your estate, but, Business Property Relief (BPR) may allow you to pass on some of the business tax-free either through your will or when you are still alive. `

Business property relief can only be claimed in respect of business property which has been ownded for at least two years.

You can claim BPR on:

• a business or an interest in a business
• unlisted shares (shares that aren’t listed on a recognised stock exchange), including shares that are traded on the Alternative Investment Market
• a holding of shares or securities that you own which give you control of a company, that are fully listed on a recognised stock exchange
• any land, buildings, machinery or plant which was used wholly for the purposes of a business carried on by a company you control or by a Partnership of which you are a partner

You can’t claim BPR on a business asset if the asset:

• also qualifies for Agricultural Relief
• was not used mainly for business in the two years immediately before you passed it on as a gift during your life, or as part of your will
• is not required for future use in the business

Rates

If the asset qualifies for BPR, relief is given at either 50 or 100 per cent, depending on the type of asset.

For interest in a business, or a holding of shares in an unlisted company, then 100% relief is applicable.

The 50% rate is applicable to:

• shares controlling more than 50 %of the voting rights in a listed company
• land, buildings, plant or machinery used in a business that you are a partner in or control at the time of your death
• land, buildings, plant or machinery used in your business in which you hold an interest in possession held in a trust .

Inheritance Tax is a very lucrative tax for the government. Its purpose is to put money back into society so everybody can benefit, however many people say that tax was paid at the time of purchase on possessions and income tax paid at the time on earnings so it is unfair to pay tax twice.

Inheritance Tax cannot always be avoided, but it can be significantly reduced. It therefore helps to know what is available to you so that you can enlist the advice of professionals who will give you more detailed advice and help you to implement the above tax-reducing measures. It is often worth paying £1000 for advice in order to save £100,000 in tax.

Contact us for further details:

Phone: 020 7354 3914