We all want to protect our wealth and help ensure our families are provided for when we die. However, increasingly HM Revenue & Customs (HMRC) are challenging the valuations of properties given for Inheritance Tax (IHT) purposes, according to accountants UHY Hacker Young.
IHT is currently payable at 40 per cent on any amount over £325,000 – the nil rate band (tax year 2011/12). The nil rate band is the term used to describe the value an estate can have before it is taxed (£650,000 for married couples). So if you have an estate worth £500,000, £175,000 is taxed at 40 per cent, meaning the IHT bill would be £70,000.
The taxman raised £70m in additional tax last year – an average of £24,600 extra tax per case – and are targeting beneficiaries who claim a property they’ve inherited is worth less than it is in order to pay less tax.
During the financial year 2010/11, 16,000 estates paid IHT. Of these, more than a fifth – 3,441 – had the valuation of the property increased, while just 800 had valuations reduced, according to HMRC figures.
Reducing an Inheritance Tax bill
Write a Will
Making a Will is the first step to reducing your IHT bill. It helps you get an idea of what your estate is worth, therefore providing a good basis to understand how much IHT planning is required.
You can give away cash or assets up to the value of £3,000 a year without it incurring any taxes. This can also be backdated by one year if not already used, for example, a couple could effectively gift £12,000 in the first year if not already used and then £6,000 (£3,000 each) thereafter. Parents can also give up to £5,000 to each of their children as a wedding/civil partnership gift while grandparents can give up to £2,500. Others can also contribute to loved ones’ weddings/civil partnerships but are only allowed to give up to £1,000.
You can make small gifts up to £250 to as many people as you like, as long as you haven’t already gifted that person in the same tax year.
If you are still working and earning an income, you are also permitted to give away any surplus amounts of your income provided that, in making these gifts, your own standard of living is not affected. You must not then access your capital (savings and investments) to live off.
The seven-year rule allows you to make additional tax-free gifts providing you do not pass away within the next seven years. These gifts are called ‘potentially exempt transfers’ (PETs) and can be anything from cash to property. However, you cannot give something away and still benefit from it, for example, you can’t give away the family home and then continue to live in it unless you pay the market rent.
If you were to pass away before the seven years were up, the assets would be taxable. However, the amount would vary and depend on how close to the seven-year milestone you were. For example, if you were to die within six years, the tax bill would be less than if you passed away within a couple of months. This is known as ‘taper relief’.
A matter of trust
Placing assets into a trust in your lifetime could be a good way to decrease your IHT bill. Limited to the nil rate band, these gifts count as potentially exempt transfers. This means the same rules apply, so if you pass away before the seven years are up, IHT will be due.
It is possible for a Settlor to place assets in excess of the nil rate band in a trust. These gifts are called ‘chargeable transfers’ as tax is payable immediately the asset goes into the trust. However, if the Settlor dies within seven years then there could be an IHT liability to pay too.
Buying farmland is an alternative way to help reduce a potential IHT bill, as farmland qualifies for agricultural property relief of up to 100 per cent after two years of ownership. The land has to be actively worked on for ‘agricultural purposes’ so, unless you have rural ambitions, this will not be an option for the majority. ν
Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.