How to Avoid Inheritance Tax

Published on September 16, 2014 by Shamini Raj in News, Property Investment

The Dreaded Inheritance Tax! Unfortunately, this is one item that I and my siblings have had to consider carefully in what will probably be the inevitable very near future. It is not that the potential amount will be less than £300,000, but also how it could affect us individually within our own future timeline.

Now I am neither a tax expert nor a legal one but I have delved in to the reams of technical information that is available to try and condense the basics into this article.

The main issue relates to the value of the inheritance. At the present moment, if the assets are above £325,000 for individuals or a combined allowance of £650,000 for married couples, a 40% tax rate will apply on the amount above the limit. The main asset of most families is that of the home property and with the recent increase in property values, the limit currently applied can in many instances, be considerably lower than the actual value of the asset. There is a proposal by the current  Prime Minister David Cameron to increase the limit to £1 million but as with most things political, there is no indication as to when or indeed if this will occur. This means that whilst the value of the assets is below £325,000, then they are exempt but amounts above this limit are not so lucky.

There are three main areas to consider so let us look at these individually.

Persons Living in the UK

Many families leave consideration of Inheritance Tax until it is too late! By this I mean that if you are a parent, you just cannot simply give your property away to your children before you “pass on” and in so doing hope to avoid the tax.

The rules are quite clear on this point. The gift, whether it is in the form of property or anything else of value, must be made seven years or more prior to the death of that individual. Anything less than that period renders the asset liable to Inheritance Tax should it be above the limit. Currently, the level of Inheritance Tax is deemed to be 40% on anything above the limit which can be quite a considerable amount, especially when one considers the current value of property in various parts of the UK, particularly the South East of England.

Let us suppose for one moment that a parent decides to gift the matrimonial home to the children but selects to live on in the same property. Not many people realise that unless a “market” rent is paid by the parent, even though the gift was allegedly made more than seven years prior to the death, HMRC will consider this to be a “gift with reservation of benefit.” Effectively what this means is that whilst the parent may have made a gift, they have in fact benefited from it by living in the house rent free. This in turn means that the property does not qualify for any exemption of Inheritance Tax. What could be even worse is that on the actual death of the parent, the siblings sell the property thinking that they can benefit in full from the proceeds of the sale.

Unfortunately this is not the case. Since no rent was paid, the property did not fall for full consideration under the terms and conditions of the Inheritance Tax. Therefore when it was sold, the property also becomes liable for Capital Gains Tax because the property was also not the prime residence of each sibling.

It is obvious that the question of Inheritance Tax is extremely complicated. There are a number of options that you must consider carefully.

1. It is essential that the parent makes a will, even though the parent or spouse’ intention was to leave all assets to the spouse or children. If this is not done, then the parent will be deemed to have died “intestate” which means that the parent has absolutely no control as to how the assets will be distributed.
2. You are allowed to give a sum up to £3,000 each year as a parent to each of your children. As well as that, should your children get married, as well as probably paying for the wedding (!) you are also allowed to give them a gift which should not be more than £5,000 – remember that this applies even if you have more than one child and also is from each parent.
3. Family trusts can be established at minimal costs as a way of avoiding Inheritance Tax, yet at the same time preventing the beneficiaries, usually the children, from blowing the assets on a money spending binge!
4. There is another range of interesting items that can be used to substantially cut potential tax bills. These include making regular gifts from a person’s income; consideration should the death of the parent have resulted from an injury received during military service and also from leaving the country altogether!

Persons Living outside the UK

If you live outside the UK and part of your intention is to avoid inheritance tax, you need to be extremely careful in your definition of “domicile” and “resident for tax purposes.” One of the main methods of defining your actual domiciliary is the country in which it is your intention to be buried. For example there are many British expatriates living in Spain and of course they take advantage of the tax benefits that this allows them. They are deemed to be resident in Spain for tax purposes. However, upon death, if it is their intention to be buried in the UK, then any inheritance tax due would be from your worldwide assets and not only those that may be located within the UK.

Nursing Home Fees

There is often the misconception that the amount of assets for Nursing Home fees is the same as that for inheritance tax i.e. £325,000 – it is not! Payment of nursing home fees is means-tested! If your assets are between £14,000 and £23,000, then the state will contribute towards the cost of any nursing home fees. If they are below £14,000, then the state will pay the full costs whereas if they are in excess of £23,000, then you must pay for your own care.

You must be very careful if it is your intention to sell your home, probably your main asset, before you go into care. Local authorities take a very dim view of people who try to avoid paying nursing home fees and such an attempted act is known as “deliberate deprivation.”

There is no question that the tentacles of Inheritance Tax reach far and wide. Never forget the difference between “evasion” and “avoidance” and it is therefore essential that you do take both legal and accountancy advice, particularly if your assets fully exceed the current limit of £325,000.

References:

• http://www.hmrc.gov.uk/inheritancetax/pass-money-property/
• https://www.gov.uk/inheritance-tax/inheritance-tax-when-someone-living-outside-the-uk-dies

About the author

Shamini: A Chartered Accountant turned Serial Entrepreneur who has a passion for business, finding creative solutions to problems and love inspiring others to make a difference.