What is Inheritance Tax (IHT) and how to minimise the tax bill?

What is Inheritance Tax (IHT) and how to minimise the tax bill?

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Date02 Sep 2013
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Posted ByAdmin
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With Inheritance Tax in the news, we thought a quick overview of how to best manage it would be of interest.

What is Inheritance Tax (IHT)?

As the name suggests, it is imposed on an heir when they inherit property or money from a deceased person.  It is a tax paid on the value of the deceased person’s estate above the IHT nil rate band/threshold, which is currently £325,000.

The tax is set at 40% of any value above the nil rate band, reduced to 36% if more than 10% of the estate is left to charity. To work out how much IHT, if any, needs to be paid, you will need to:

  • add up the value of all of the assets (including including gifts made in the 7 years before the person died)
  • then subtract any debts like bills and funeral expenses

You usually have to pay Inheritance Tax within 6 months from the end of the month in which the person died - after this you have to pay interest on top of the amount. Sometimes it can take more than 6 months to deal with the deceased’s details and start paying Inheritance Tax.  If you make an early payment as an estimate, you won’t have to pay interest on the amount you pay.  You may also earn some interest if you end up overpaying.

Tips to minimise your IHT bill

Increased vigilance by the HMRC on tax dodgers has led to a rise in IHT tax-take this year.  According to The Office of National Statistics, at £3.1bn IHT in the year to April, it is the highest IHT-take since 2007. But being tax efficient isn’t a crime and there are a number of legitimate ways to reduce the amount of IHT you will pay after you have inherited property, gifts or money.  Some of these are outlined below:

The things outlined above might help reduce your IHT bill, but there are some things which will not have an impact. A good financial adviser should be able to help you organise things in such a way that you do not end up paying more IHT than you need to.

  1. Use the “nil-rate” band

    You can transfer any unused Inheritance Tax threshold from a late spouse or civil partner to the second spouse or civil partner when they die. This can increase the Inheritance Tax threshold of the second partner - from £325,000 to as much as £650,000 in 2013-14.  Transfers between husband and wife are exempt for IHT and therefore no tax is payable on the death of the first spouse.

  2. Gifts & exemptions

    One way of planning for IHT is to be generous and give assets away during life - though the gift has to be more than 7 years before death to escape the net. The current inheritance tax threshold is £325,000, above which estates are taxed at 40%. “Given that modern houses can easily cover this amount, now may be the time to start gifting money - up to £3,000 a year - to minimise the tax burden on your heirs”, says Alan McCappin, Practice Manager at Bradleys Accountants.

    There are other gifts which are completely exempt, but they need to be made quickly. These are:

    • Gifts or legacies to a spouse/ civil partner are, as mentioned earlier, fully exempt (unless they are non-domiciled)
    • Gifts to charity and some other organisations, including museums, universities, community amateur sports clubs and the National Trust
    • Small gifts of up to £250 a year to as many people as you want

    The 7 year rule: Ensure gifts and assets are given to family early on, so that they are exempt after 7 years of ownership. However, you also need to ensure that gifts are given in their entirety.

  3. Plan ahead

    As with all tax planning, planning for the long term rather than at the last minute is the way forward. If you are an individual, make sure that you take full advantage of statutory reliefs and exemptions.  And if you are a business owner, ensure that your business interests are structured in a way that secures the maximum amount of relief. For instance: Business property relief (BPR) can provide a reduction of 100% (50% in limited circumstances) in the net value of relevant property in a qualifying business for inheritance tax purposes.

  4. Set up a discretionary trust

    If you want to make gifts but still have control of your assets, you can set up a discretionary trust. This planning still works, but rules are getting tighter.