Dispelling the myth about inheritance tax

Protecting wealth from a potential liability

Inheritance Tax is the tax that is paid on your ‘estate,’ chargeable at a current rate of 40 per cent. Broadly speaking this is a tax on everything you own at the time of your death, less what you owe. It’s also sometimes payable on assets you may have given away during your lifetime. Assets include property, possessions, money and investments. One thing is certain, careful planning is required to protect your wealth form a potential Inheritance Tax liability.

Not everyone pays Inheritance Tax on their death. It only applies if the taxable value of your estate (including your share of any jointly owned assets and assets held in some types of trusts) when you die is above £325,000 (2009/10 tax year). It is only payable on the excess above this nil rate band.

There are also a number of exemptions which allow you to pass on amounts (during your lifetime or in your will) without any Inheritance Tax being due, for example:

if your estate passes to your husband, wife or civil partner and you are both domiciled in the UK there is no Inheritance Tax to pay even if it’s above the current £325,000 nil rate band

most gifts made more than 7 years before your death are exempt

certain other gifts, such as wedding gifts and gifts in anticipation of a civil partnership up to £5,000 (depending on the relationship between the giver and the recipient), gifts to charity, and £3,000 given away each year are also exempt

Transfers of assets into most trusts and companies will become subject to an immediate Inheritance Tax charge if they exceed the Inheritance Tax nil rate band (taking into account the previous 7 years’ chargeable gifts and transfers).

In addition transfers of money or property into most trusts are also subject to an immediate Inheritance Tax charge on values that exceed the Inheritance Tax nil rate band. Tax is also payable ten-yearly on the value of trust assets above the nil rate band, however certain trusts are exempt from these rules.

The current Inheritance Tax nil rate band is £325,000 (tax year 2009/10). In order to work out whether the Inheritance Tax nil rate band has been exceeded on a transfer you need to take into account all ‘chargeable’ (non-exempt, including potentially exempt) gifts and transfers made in the previous 7 years. If a transfer takes you over the nil rate band, Inheritance Tax is payable at 20 per cent on the excess.

Where the transfer was made after 5 April and before 1 October in any year, the tax is payable on 30 April in the following year, or where the transfer was made after 30 September and before 6 April in any year, it is payable 6 months after the end of the month in which the transfer was made.

The government changed some of the rules regarding trusts, which took effect from 22 March 2006 and introduced some transitional rules for trusts set up before this date.

Trusts not affected by the new rules (and so where no Inheritance Tax is immediately payable on any transfers, but with regard to transfers made during someone’s lifetime may be payable if the individual dies within 7 years) are:

lifetime transfers into a trust for a disabled person

trusts created on death for a disabled person

trusts created on death for a minor child of the deceased in which the child will become fully entitled to the assets at age 18

trusts set up under a will for someone who is not a disabled person or minor child of the deceased who becomes entitled to their benefit on the death of the person who wrote the will

Existing accumulation and maintenance trusts had until 6 April 2008 to change (where appropriate) the trust’s rules to enable them to fall outside the new rules.

Interest in possession (IPP) trusts that existed before
22 March 2006, or which replaced a pre-March 2006 IPP up to 5 October 2008, continue to benefit from the old rules until they come to an end. All other newly created IPP trusts will come under the new rules.

If you die within 7 years of making a transfer into a trust on which you have already paid 20 per cent Inheritance Tax the tax due is recalculated using the Inheritance Tax rate applicable on death. Tax will be payable by your estate to HM Revenue & Customs on the difference.

If you made a transfer on which no Inheritance Tax was due at the time, its value is added to your estate when working out any Inheritance Tax that might be due.

Trusts that count as ‘relevant property trusts’ must also pay:

a ‘periodic’ tax charge of up to 6 per cent on the value of trust assets over the Inheritance Tax nil rate band once every 10 years

an ‘exit’ charge proportionate to the periodic charge when funds valued above the Inheritance Tax nil rate band are taken out of a trust between 10 year anniversaries

These rules don’t apply to trusts which are exempt from the new rules.