While inheritance tax accounts for only a small amount of the overall tax paid to HM Revenue & Customs – around just 1 per cent – it is a very emotive tax in that it impacts the people we care about.
Latest figures show that HMRC’s receipts of IHT have risen from £5.3bn in 2020-2121 to £6.1bn in 2021-22. This increase is only partly explained by Covid-related deaths.
Perhaps the most concerning increase in IHT is due to the nil rate band having been frozen until 2026. This, combined with rocketing house prices, is pushing more families into the scope of IHT.
The good news is that relatively simple planning can save a significant amount of IHT. The bad news is that simple planning undertaken without sufficient tax and legal advice can result in unintended tax consequences.
Leaving IHT planning for another day
Many people find themselves within the scope of IHT because they did not start planning early enough. The plain truth is the sooner you start IHT planning, the less IHT you will pay.
Unfortunately, it is a common misconception that IHT planning has to be complex and expensive and is only relevant to the super rich.
If you do not need it, give it away
The most straight forward form of IHT planning is giving one’s assets away. Forty per cent of the value of surplus cash and assets will go to the taxman (after nil rate bands) if nothing is done. But if the intention is to pass on assets to the next generation, it would be wise to consider taking this step during one’s lifetime.
Gifting during a lifetime does have complexities. These some of the most common:
1. The 7-year rule: If you give away an asset, you need to survive seven years for the gift to be fully exempt from IHT. Surviving three to seven years will reduce the IHT due on the gift. This is called a potentially exempt transfer (PET).
A PET is said to fail if the individual making the gift dies within seven years, resulting in IHT becoming due on the gift. If a PET fails, it is the person who receives the gift who is liable for the IHT, unless the deceased’s will states otherwise.
Certain gifts from surplus income are outside the scope of IHT without the need to survive seven years.
2. The gift needs to be absolute: If an individual gives away an asset but still retains a benefit this could be ineffective.
3. Proving gifts have been made: Ensure sufficient records are kept so that executors or personal representatives can identify lifetime gifts. On death, it will be the executors who must provide details of such gifts to HMRC. An absence of information can result in additional tax being paid.
The records kept do not need to be onerous, but sufficient information should be documented to evidence the timing and nature of the gifts.