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The Inheritance Tax Trap

David Higgins of Glazers Financial Services looks into why more and more people, and not just the very rich, are falling into the inheritance tax trap and what they can do about it.

In the UK we are paying £1.24bn a year more in inheritance tax than we need to, according to IFA Promotion, the organisation which promotes the benefits of independent financial advice. Inheritance tax was introduced in 1986 to replace capital transfer tax. Since then, the way in which the tax works has changed little. What has changed is the way the government via the Inland Revenue has sought to collect inheritance tax. The Inland Revenue has progressively closed the loopholes that once existed and is increasingly looking to challenge inheritance tax savings schemes in the courts.

It is straightforward for people who are happy to give away assets, and who can afford it, to use the exemptions and allowances that exist. However, those who want to control or access capital or property may need to consider more complex approaches.

Homes valued at £250,000 or over are commonplace in the UK nowadays, so it’s easy to breach the £255,000 inheritance tax threshold. Inheritance tax doesn’t work like other taxes - it’s a 40% tax charge for everyone over this threshold. To reduce or avoid the tax completely you need to take advantage of allowances and exemptions.

The first £255,000 is exempt; meaning husband and wife can jointly leave £510,000 free of tax. Many people make the mistake of leaving everything to their partners, but on the death of the surviving spouse only £255,000 can then be passed on tax free to the rest of the family. This means that for a couple whose estate is worth £510,000, leaving the whole amount to the surviving spouse who then passes it on to the children, would leave the family with a hefty £100,000 tax bill. So it makes sense to pass part of the family fortune on to your loved ones on the first death.

On larger estates, anything passed on seven years before you die is tax-free. If you die more than three years, but less than seven years, after making the gift, there may be a reduced rate payable. You can gift away up to £3,000 a year and the allowance can be carried forward for a year if you don’t use it that year. A couple can therefore pass on £60,000 tax free in 10 years. You can make small gifts up to £250 a year, give your son or daughter up to £5,000 as a wedding gift and up to £2,500 to each grandchild on his or her wedding. These gifts must be made before the big day, and become taxable if the bride or groom calls the whole thing off.

You can also give money away if the gift is part of your normal expenditure. This means that you should be left with sufficient income to maintain your standard of living and it is important that these gifts are regular payments from income.

Gifts to charities, political parties and to the nation, such as to the National Trust or British Museum, are also exempt. If you are in business, reduced rates apply to business and farming assets too.

One needs to consider a range of approaches in addressing a potential tax liability. Often very simple solutions are the most appropriate, but inheritance tax savings must be considered alongside capital gains tax planning and other financial planning issues. Put simply, it’s no use devising a plan to save a potential inheritance tax liability where a large capital gains tax liability arises or individuals find that their standard of living is adversely affected.

Where more sophisticated schemes are used, and it often makes sense to use them, based on the fact that inheritance tax is charged at a rate of 40%, it’s worth bearing in mind those areas that the Inland Revenue might successfully challenge.

To sum up, more and more people are facing a potential inheritance tax liability and the government is working more and more proactively to collect the tax. It is certainly worth planning, and reviewing existing plans, to reduce or meet a potential liability.

If you would like to discuss your inheritance tax situation, please email David Higgins on call him on 020 8458 7427.

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