Inheritance tax planning at the 11th hour

An increasing number of estates are falling into the range of Inheritance Tax (IHT); if IHT were ever the concern only of the ‘rich’, it certainly isn’t now.

As ever, those with wealth less than the nil rate bands, needn’t worry about IHT.  And the very rich may be able to engage in effective planning without affecting their standard of living.

It’s the moderately well off who face the thorny dilemma of a sizeable IHT bill – but with limited opportunity for effective planning.

I regularly advise clients that freedom from financial worry in old age is far more important than saving IHT on the free money to be inherited by their vile and undeserving children (I always say that with my tongue clearly and firmly in my cheek- well, almost always…).

The need to preserve assets to fund an ever-longer old age precludes so many from putting their resources at risk, or handing them over early to the next generation. We can’t know when we’re going to die. So unless we can identify a value that will never be required, however long we live, so that it’s nothing but an IHT bill waiting to happen, our opportunities for lifetime giving to save tax are constrained.

The upshot of this IHT exposure with limited scope for mitigation is, thus, according to the Office for Tax Simplification, that the estates of moderately-well-off people see a much larger percentage of their value disappear in IHT than is the case with very large estates.

There may come a point, normally with the diagnosis of a terminal illness, when sadly the timetable, likely short, for the rest of our life becomes clearer. As a result, the likely IHT payable on our death can be calculated with greater certainty and the amount which, perhaps, might safely be given away can be quantified. Conversely, the circumstances that bring such certainty may render next to nil the chances of our surviving the seven years required for the value given to drop out of account for IHT purposes.

That said, there exists quite a raft of potential last minute tax planning opportunities:

• Get married (or enter into a civil partnership). If you intend to leave your estate to your long term partner, there’ll be a charge to IHT on your death - and, again, on their death when assets are left, say, to your children. If you marry him/her, the whole of your estate, however large, will pass to him/her tax free on your death (the spouse exemption) even if you die within days of the marriage.

• Use your annual exemption. You can give away £3,000 per annum, tax free (£6000 if you haven’t used last year’s exemption). There’s no required survivorship period.

• Invest in assets qualifying for IHT relief. Certain business and agricultural assets attract 100% relief from IHT after two years’ ownership. Something to consider, perhaps, where there’s a fair chance of surviving two years but not seven. There exist a number of investment choices that qualify for relief; but it’s imperative that you take expert advice. The attractiveness of the relief is counterbalanced by the degree of investment risk that needs to be accepted.

• Make gifts to take your remaining estate below £2 million.  It’s accepted in many quarters that a number of people (the ‘accidentally rich’, to steal a phrase from the Daily Telegraph) have drifted into the IHT net purely by reason of the increase in property values (especially in the South East). To soften the IHT blow, the Government introduced the additional ‘Residence Nil Rate Band’; on deaths after 5^th April next year the band will be increased to £175,000.  This will mean the estates of a married couple, on the second death, may benefit from a total nil rate band of £1million provided the estate contains a home (or the proceeds of sale of a home if the couple/survivor had downsized or, perhaps, sold up and moved to a nursing home) – and that home is left to ‘qualifying descendants’.

The available Residence Nil Rate Band tapers off once the net estate on death exceeds £2 million. So lifetime gifts might sensibly be made shortly before expected death to bring the estate down to a level where the full Residence Nil Rate Band can be claimed. Substantial tax savings will thus be achieved even though the gifts themselves remain chargeable to IHT.

The Residence Nil rate Band is calculated by reference to the NET estate. So where gifts of assets in the estate aren’t possible (perhaps the ONLY asset in the estate is a house worth over £2 million), there’s nothing to stop you borrowing money and giving that borrowed money away to reduce the net value.

• Don’t forget Capital Gains Tax on Gifts… 

This isn’t the first blog I’ve written which contains a reminder not to look at individual taxes in isolation . See: IHT and CGT - uncomfortable bedfellows? Don’t overlook possible Capital Gains Tax exposure in your Inheritance Tax Planning

Remember that a lifetime gift of an investment rather than cash (perhaps made to reduce the estate below £2 million) may attract Capital Gains Tax (CGT). A gift chargeable to CGT which then falls to be charged to IHT on subsequent death will see the value given effectively charged to BOTH taxes.

• …and the CGT base value uplift on death

Where assets are left to a surviving husband/wife/civil partner by will, not only does the survivor inherit those assets free of IHT but there’s an uplift in base value to the date of death.

On a sale by the survivor, the gain chargeable to CGT is calculated by reference to the date of death, not the date their spouse originally acquired them. Any gains up to that date aren’t chargeable. It’s brutally common tax planning for a healthy person to give assets to their dying spouse - with view to receiving them back again shortly on that spouse’s death with the CGT slate wiped clean.

‘Death bed’ tax planning isn’t an easy subject to broach with either client or their family. It’s fair to say, however, that, usually, it’s the client themselves who raises the issue, despite their illness.

In other cases, while tax planning may be obvious and useful, there’s both mental as well as physical deterioration. Mental capacity is needed to make gifts; a person with a Power of Attorney won’t have such power without application to the Court (which takes time – of which there may be very little left).

Subject to any restrictions in the power of attorney document (unlikely), there is, however, power for an attorney to invest in assets that qualify for relief if the donor of the power survives two years. Persons acting under a power of attorney owe a duty only to the donor. Using investment powers to save IHT for the donor’s family will likely be considered a fulfilment of that duty if the financial needs of the donor in the short time they have left are not prejudiced.

About the author

Jim Sawer is a partner in our private client team. He has a broad private client practice and has advised families in the UK and overseas, including those with commercial and landed interests, for over 30 years.  Clients appreciate his ability to identify the true crux of a matter promptly and his results-orientated approach to resolving private client issues in the family context.