“ ...The only things that are certain in life are death and taxes...”

Considering Benjamin Franklins famous quote, how do death and tax correlate? Inheritance Tax.

Inheritance Tax (IHT) used to concern only the wealthy, but years of rising house prices in the boom 90’s and early years of this millennium have brought many more people into the Inheritance Tax threshold, and moved IHT higher up the political agenda for debate.

How does IHT affect you?

IHT is paid on your estate when you die and also when money is transferred into some trust funds. Some other transfers during one’s lifetime may also be subject to IHT. The first £325,000 (at 2011/12 rates) of the estate is “exempt” from IHT (but see below). This is called the nil rate band (NRB).

In simple terms, the assets in the estate are valued on death, any transfers of value made within seven years prior to death which are brought back into the value of the estate for IHT purposes, the NRB subtracted and the remainder of the estate is taxed at the higher rate of 40%.

The common misconception is that there is one rate of IHT, in fact there are three.

• Cumulative chargeable lifetime transfers above the NRB threshold are taxed at 20%

• For death triggered charges the current lower band is £0 to £325,000 (the NRB) and in this range IHT is charged at 0%. The legislation is drafted so that although unlikely the government is always able to raise this level from nil to generate revenue.

• Any surplus value above £325,000 (the NRB) is taxable at a rate of 40%.

Prior to 2007, leaving everything to a spouse could be tax inefficient. When the second spouse died, anything over £300,000 of joint assets was exposed to IHT, meaning effectively that the estate of the first spouse to die had wasted their tax-free allowance. This was the era of the Nil-Rate Band Discretionary Will Trust which provided set up in Wills, so that the first spouse to die utilised their nil-rate band

Previously, this nil-rate threshold changed every year. The Conservative Party suggested that their intention was to raise it to £1,000,000 but, with the formation of the coalition government and state of the exchequer, it was announced in the 2010 budget that the rate would be frozen for four years, effectively decreasing it in real terms (ie. when inflation is factored in).

Most estates don't have to pay Inheritance Tax because they're valued at less than the threshold (£325,000 in 2011-12).

Inheritance Tax is payable by different people in different circumstances:

• Typically, the personal representative pays it using funds from the deceased's estate.
• The trustees are usually responsible for paying Inheritance Tax on assets in, or transferred into, a trust.
• Occasionally recipients of gifts, or beneficiaries who inherit from the deceased, have to pay IHT.

Exemptions and reliefs

Based on your circumstances, even if your estate is over the threshold, you can pass on assets without having to pay Inheritance Tax.

• Spouse or civil partner exemption - Your estate usually will not be liable to IHT on anything you leave to a spouse or civil partner who has their permanent home in the UK - nor on gifts you make to them in your lifetime - even if the amount is over the threshold.
• Charity exemption - Any gifts you make to a 'qualifying' charity - during your lifetime or in your will - will be exempt from IHT.
• Potentially exempt transfers (PET’s) - If you survive for seven years after making a gift to someone, the gift is generally exempt from IHT, no matter what the value.
• Annual exemption - You can give up to £3,000 away each year, either as a single gift or as several gifts adding up to that amount - you can also use your unused allowance from the previous year but you use the current year’s allowance first.
• Small gift exemption - You can make small gifts of up to £250 to as many individuals as you like tax-free.
• Wedding and civil partnership gifts - Gifts to someone getting married or registering a civil partnership are exempt up to a certain amount.
• Gifts made ‘out of excess income’ - If you make such gifts this should not affect your lifestyle and usually must be regular. Gifts must be justifiable and records kept. HMRC do look carefully at such gifts with a view to disallowing them when possible.

A note about gifts

A gift must be a genuine unconditional gift that you will not gain from; something given to someone without any reservation. Many gifts are a valid ways of reducing your IHT liability but if given conditionally, with the intention of receiving something in return, they will probably fail.

The biggest asset most people have is their home, There can be tax implications if you give your home away to your children or someone else - especially while you’re still alive. If you give your home away and continue to live in it, the “gift with reservation of benefit” or “pre-owned assets” rule will probably apply and your estate or the person you gave your home to might still have to pay:

• Inheritance Tax on the property when you die

• other taxes such as Income Tax

Certain types of property can be passed on free from IHT - or at a discounted value for IHT purposes.

Business relief (BPR)

This is quite a complex relief and some things qualify whilst others don't but in simple terms it allows you to pass on business assets without the payment of IHT. Businesses benefit from a more generous taxation system because of their role in providing economic growth.

BPR can provide 100% relief from IHT on a sole trader’s business or partnership interests and can apply to shares in trading companies that are not quoted on a recognised stock exchange. Shares quoted on the Alternative Investment Market can also be eligible for 100% BPR. There is no limit to the value of BPR which can be claimed. Business assets must have been owned by the donor for two years to qualify for BPR and the business in respect of which a claim is made must also be wholly or mainly a trading company. Investment companies and businesses dealing in shares, stocks, securities, lands or buildings do not qualify for BPR.

BPR at 50% is available on land, machinery, plant and buildings used for business purposes, although they will need to have been owned and used mainly for business purposes within the past two years. It is also available for shares in quoted companies where the shareholder has a controlling interest of more than 50%.

In the context of a family business, it may be preferable for a donor to leave IHT-exempt assets to a beneficiary other than their spouse or civil partner. There is no saving if business assets are passed to a beneficiary who would not be liable for IHT anyway. For example, a transfer of business assets qualifying for BPR to a spouse would achieve no IHT saving on that transfer, because transfers between spouses are normally exempt from IHT in any event. There are several issues to consider and expert advice is essential when undertaking IHT planning with regard to business assets.

Agricultural property relief (APR)

This one is much simpler it is attributed to agricultural property such as farms etc. It includes farmland and buildings and property but does not include machinery. That said the machinery may qualify for BPR.

Other ways to reduce or mitigate IHT

Equity Release

An Equity Release Scheme (of which there are several types) allows money locked in freeholds to be released. This can be given away as a PET and if the donor survives more than seven years then it will not normally attract an IHT liability.

Life Assurance

Policies are available which may pay all or some of your IHT liability. These can be written in such a way that they pass directly to your family and do not become part of your taxable estate. Lump sums payable on the death of a pension policy holder can also normally be arranged to fall outside your estate.

Holding Exempt Assets

Certain assets (such as shares in AIM-listed companies and in family businesses) are wholly or partially exempt from IHT if certain conditions are met. (see BPR )

Trust Funds

Setting up a trust fund used to be a common way to leave money. This can be an effective way of minimizing the impact of IHT. However, changes made in the 2006 Finance Act have made some of these less attractive.