Inheritance Tax Planning

Inheritance Tax is a tax on your wealth. And the only way to reduce that tax is to reduce the value of your wealth (your estate).

For the vast majority of people, Inheritance Tax planning need not be complicated. It is a tax which becomes due when you pass assets you own to someone else. This will almost invariably happen when you die but can also occur - 'though not often - during your lifetime.

To see where you stand in this respect you only have to follow 6 basic fundamental steps.

STEP 1

Ascertain whether you do have an Inheritance Tax problem. In other words, if you do nothing, will Inheritance Tax become due when you (or your 'other half') die?

As with income tax allowances, there is a bottom layer of your wealth which escapes Inheritance Tax. This layer is called the nil rate band. Only assets above that level can be taxable.

Whether or not you believe your assets are sizeable enough to attract Inheritance Tax, it is wise in the extreme to ensure that you have a valid Will. This ensures your assets pass to whom or where you want (always assuming, of course, you do actually have something to leave%u2026!).

STEP 2

This step is decision time. Assuming you believe you have an Inheritance Tax problem, do you want to do anything about it? You have three alternatives:

1. Do Nothing. "The kids can pay the tax out of 'what's left' after we have enjoyed ourselves. And probably still have more than we inherited!"

2. Tie yourself up in knots with complex trusts. Lose control. Lose all important flexibility. All to beat the tax man.

3. A satisfying course somewhere in between.

The decision you make is likely to depend upon your answer to this question, "To what extent does a large Inheritance Tax bill, depriving children and grandchildren, bother you?"

Provided your decision is not to do nothing, there are a sequence of sensible logical steps forward.

STEP 3

This step should investigate whether you can claim the nil rate band (nrb) twice, i.e. on the occasion of the death of both partners?

For single folk the nrb is automatic and available once, i.e. on death. The same applies to married couples and those in a civil partnership where the nrb is available twice, i.e. on both the first and second death.

In October 2007 transferability of the nrb came into effect. This affects mainly widows and widowers who may be able to claim any part of the nrb not used when the first spouse died. In other words claim any part of the nrb twice. This would be good. Two layers of wealth not taxable. But the position can be anything but straightforward. The transfer is not automatic. It has to be claimed. And this is where problems arise.

Claiming that second nrb is not as simple as people imagine or believe. You have to prove your case to the tax man. This needs a good deal of old documentation that quite often is not available. How many of us, for example, can lay our hands on death certificates, Wills, probate, etc. that might go back 20 or 30 years?!

Our advice therefore, in the majority of cases, is do not rely on what may prove to be unclaimable.

Plan anyway.

STEP 4

Where you are able to, make use of available EXEMPTIONS.

Exemptions are good. This is because they reduce the value of your estate at exactly the same time as you pass those assets out of your estate. This is not always the case. In certain circumstances a gift can pass legally to the recipient whilst the value of the gift remains in the donor's estate for Inheritance Tax purposes.

So Exemptions - there are half a dozen or so of them - should be taken advantage of wherever possible. But because they are 'good' there are limits on the size.

STEP 5

Consider removing assets (make gifts) in excess of the Exemptions.

But if you make a gift in excess of the Exemption limits, it could fall within the '7 year rule' and the 'Gift with Reservation rule'. The easy (and incorrect) description of these rules is frequently cited as, "live 7 years from the date of the gift and that gift will be outside your estate for Inheritance Tax purposes."

More correctly, you have to consider the 7 year period immediately prior to your death. Somewhat difficult because most people do not know that specific date (!).

In that period prior to death you must have enjoyed no benefit from the gift. If you have, the gift will be counted - for Inheritance Tax purposes - as having never left your estate.

The classic example is parents gifting their home to the children but continuing to live on the premises. It does not work so far as Inheritance Tax is concerned because of the Gift with Reservation rule.

Another example is giving the kids the villa in Spain and continuing to use it even if only a couple of times a year. It does not work unless you take further action.

TRUSTS

Don't use them unnecessarily!

In essence the principle of trusts is simplicity itself. Trusts can become complex (which the legal profession love - more fee income for them!) but the underlying objective is straightforward. A trust is simply a way of gifting assets out of your estate but preventing the recipient from getting hold of that gift until a later date.

Examples:

1. Leaving money to minors with the stipulation they are not to receive until age (say) 30.

2. "Here are the grandkids Christmas presents but don't let them have them until 25th December."

Getting assets out of your estate is important because of the 7 year and Gift with Reservation rules. But whilst the use of trusts may seem necessary for a variety of reasons, they can reduce both flexibility and control.

In the circumstances it maybe preferable to consider instead the method described in Step 6.

STEP 6

For many people solving their Inheritance Tax problem by making gifts - substantial or otherwise - is just not an option because of the potential loss of control and the fact that the capital may be needed (long term care?) in the years ahead.

There is a way to overcome this dilemma.

How about a perfectly legitimate arrangement where you retain control and access to your capital but enjoy significant Inheritance Tax advantages at the same time?

The main advantage being that the assets leave your estate in 2 not 7 years. And the Gift with Reservation rule does not apply because there is no gift.

In a nutshell we hope the above has demonstrated that Inheritance Tax planning need not be complex. Nonetheless it makes sense to involve an independent professional adviser. Porter Brown is here to help if you need us.

But, whatever your decision regarding Inheritance Tax please remember that at the end of the day any planning undertaken should have been a pleasure - not a burden. Something you are genuinely pleased to have done.