Inheritance Tax (IHT) remains a huge hurdle for landed families. Although today’s tax environment is more reasonable than the punitive tax regimes of the late 1960s and 1970s, it’s still far from generous. Although agricultural property is subject to reliefs that remove those assets from liability to IHT and help to preserve agricultural holdings, rural jobs and help with food production, no such thing is available for residential property.
Worse, residential housing values have increased immensely in the past decades, but the portion of individual worth that’s not liable to tax has failed to grow at the same rate. As a result, owners are faced with the possibility of losing 40% of their housing stock to settle the IHT liability arising on death. This makes it critical for landed families to minimise the effect of IHT and to make best use of the tax relief available.
The basic rules of IHT
IHT is payable on the death of an individual. The liability amounts to 40% of the net assets in excess of £325,000. For married couples and those in civil partnerships, the limit is twice this figure and any inter-spouse transfers are fully exempt, provided the spouses are both UK domiciled. Relief is available, usually at 100%, for interests in businesses (mostly unquoted, although there are some exceptions) and for agricultural land and appropriate associated buildings. The rules are complex so it’s worth consulting a specialist.
Make a succession plan
A succession plan ensures you know what will happen to your assets-you will be able to gauge who gets what, including the taxman. A good plan sets the goals and objectives of succession and incorporates some degree of flexibility to help cope with the unknown. Minimising taxation will always be an important part of any plan, but it’s vital that the ‘tax tail doesn’t wag the dog’. Often, succession plans are purely IHT driven and don’t take account of family issues, including the sometimes very different values, views and needs each generation has. Security needs to come first in any good strategy-both security of ownership and, secondly and often in direct relation with the former, financial security.
In this context, thought needs to be given to the recipient of the inheritance-what will be the implications on their financial position? A good succession plan should also dovetail with your will and that of your spouse if you’re married. Ensure you communicate your plan to your family and your advisors and review it regularly to take new tax laws and changes in your personal circumstances into account.
Write a will
This is a simple first step to reducing an IHT bill and, most importantly, it will ensure that your assets pass to the people you want to receive them. This is an area of particular importance where second families are involved.
Minimise your estate
With the prospect of paying 40% on estates worth over £325,000, for individuals, or £650,000 for married couples, it’s important to know the true value of all your property, savings, investments and
personal possessions. This will allow you to work out your exposure to IHT and implement a plan to reduce it. You can’t be taxed on money that was never yours, so ensure that as much as possible is outside your estate-especially any life-insurance plans, which should be written in trust. However, make sure you don’t compromise your own financial security as a result.
Set up a trust
Aside from wills, trusts can help in estate IHT planning. They can ensure financial security for a surviving spouse, yet guarantee that the underlying assets go to, say, the children from a first marriage. However, specialist advice is essential for anyone considering setting up trusts.
Think about your house
The house is often a family’s most valuable asset, and requires serious consideration for IHT purposes. The Treasury has clamped down on the various schemes that previously allowed people to continue living in their houses after having given them away. Living rent-free in a house you once owned is simply not an option. The only real way to make this work is to pay a market rent. If you’re part of a couple that owns a property together, you also need to understand whether the house’s disposal for inheritance purposes will be directed by your will or by the manner in which you own it.
Marry and stay married
Anything you pass on to a spouse is free of IHT. Legacies between unmarried couples aren’t tax free, which is a serious problem when a couple jointly own their home. This can lead to people having to pay an IHT bill just to continue living in their home.
But plan for divorce
Divorce is having an increasing impact on families, with estates being broken up to fund proceedings, and donors are concerned about the impact of their heir divorcing. Some measure of protection is possible through pre- and post-nuptial agreements. However, the protection of trust structures is probably not as strong as it once was. So today, a good succession plan needs to consider the possibility of divorce and incorporate as many safeguards as possible.
Use annual allowances and the gift regime
Although it’s relatively modest, it’s worth making use of the annual allowance gifts of up to £3,000 each tax year and unlimited gifts of up to £250 a person per tax year. For parents with children getting married, there is an additional IHT-free opportunity to give up to £5,000 for wedding gifts. Lastly, gifts of any value can be given to anyone and, provided the donor survives for seven years, there will be no IHT under the Potentially Exempt Transfer regime. However, a gift of an asset will be a disposal for Capital Gains Tax purposes and, could be immediately assessable to tax.
Make shrewd investments
Many landed estates have favourable tax exemptions as they hold agricultural property, or operate working farms and woodlands. Some investments are also given favourable treatment for IHT purposes, including shares in unquoted trading businesses and most shares on the Alternative Investment Market (AIM).
If you’ve spent your income, there will be no liability, as you haven’t got it when you die. You can give away surplus income, but this needs to be carefully documented.
Pay IHT in advance
Life assurance policies can be purchased which will provide a lump sum on death. Provided it’s held in a trust that is outside an estate, all the proceeds will be available to help with the IHT burden.
Mike Harrison is a partner of Saffery Champness Landed Estates & Rural Business Group with particular expertise in advising private clients, trustees, landed estates, other property owners and family businesses on taxation issues, succession planning and financial matters