:: Inheritance Tax ::

52 Ways to Save Tax #11

Inheritance Tax is paid if a person’s estate (their property, money and possessions) is worth more than £325,000 when they die. Currently charged at a rate of 40 per cent, an inheritance tax bill on a large estate can run into tens or even hundreds of thousands of pounds.

However, there are ways of reducing your inheritance tax liability by making gifts while you are alive. In the next part of our series ‘52 Ways to Save Tax’ we look how you can pay less tax by giving money away. Keep reading to find out more.

52 Ways to Save Tax – Part 11: Give money away

There are several ways of making gifts and reducing your potential tax bill. These include:

Giving small gifts

In each tax year, you can gift up to £250 to as many people as you like, completely free of Inheritance Tax. Wedding gifts and individual gifts up to this amount can be given to as many different people as you wish.

Remember that you can’t give a larger sum of money and claim exemption for the first £250.

Give up to £3,000 every year

As well as the individual £250 gift limit you can also give away £3,000 in total each tax year – although you can’t combine these two allowances with gifts to the same person.

The estate won’t pay any Inheritance Tax on up to £3,000 worth of gifts given away by the deceased in each tax year (6 April to 5 April). This is called your ‘annual exemption’.

If you don’t use your annual exemption you can carry it over into the next tax year, but the maximum exemption is £6,000.

Give a wedding gift

Wedding or civil partnership ceremony gifts are also exempt from inheritance tax – although there are limits to this:

  • Parents can each give cash or gifts worth up to £5,000
  • Grandparents and great grandparents can each give cash or gifts worth up to £2,500
  • Anyone else can give cash or gifts worth £1,000

In order to qualify for this exemption you will need to give this gift (or promise to give it) on or shortly before the date of the wedding or civil partnership ceremony.

Give regular gifts from your income

There is no Inheritance Tax to pay on gifts from the deceased’s income (after they paid tax) as long as they had enough money to maintain their normal lifestyle. Such gifts may include:

  • Christmas, birthday and wedding/civil partnership anniversary presents
  • Life insurance policy premiums
  • Regular payments into a savings account

Give a gift to charity or a political party

Gifts to UK charities are also tax-free. The deceased person’s estate will pay Inheritance Tax on gifts to charities, museums, universities or community amateur sports clubs.

In addition, there is no Inheritance Tax to pay on a gift to a political party as long as they have either:

  • 2 members elected to the House of Commons
  • 1 member elected to the House of Commons and received at least 150,000 votes in a general election

Have You Taken Steps To Avoid The ‘Voluntary Tax’?

Inheritance Tax is often called the ‘voluntary tax’ as there are so many exemptions and allowances available to reduce your tax liability.  Now, the Daily Telegraph has reported that Brits pay £1.3 billion in unnecessary Inheritance Tax taxpayers due to poor inheritance tax planning, with 88 per cent of people quizzed in a recent survey saying they have done nothing to reduce the amount they will pay.

Organise your finances to avoid a large Inheritance Tax bill

The Chancellor announced in 2010 that the threshold at which people start paying Inheritance Tax will be frozen for four years at £325,000, rather than rising in line with inflation.

Karen Barrett, chief executive of consumer website unbiased.co.uk, said: “Vast sums are being paid unnecessarily in inheritance tax every year because the deceased had not made adequate provision.

“Such situations can only bring additional unwelcome stress for the deceased’s family at an already difficult time, as the tax must be paid before the estate can be released and any inheritances can be passed on.

“With the IHT threshold frozen for another three years, it is important to make sure your financial affairs are in order to protect your family and loved ones after you have gone.”

So, if you want to avoid paying Inheritance Tax, you should take steps to mitigate your liability.  Here are two easy ways.

Make a Will

This is the first step toward avoiding Inheritance Tax is to make a will.  Making a will can ensure that you leave all your assets to your spouse – a situation which results in no Inheritance Tax being paid.

However, if you die without a will you have no control over how your assets will be distributed.  Other relatives may be entitled to a share of your assets which would mean that Inheritance Tax may then be payable.

Use the Gift Exemptions

The Inheritance Tax rules allow you to make a number of different types of gifts.  The most common gifts that you can make are:

  • Annual gifts – you can give away gifts worth up to £3,000 in each tax year and these gifts will be exempt from Inheritance Tax when you die. And, you can carry forward any unused part of the £3,000 exemption to the following tax year
  • Small gifts – you can make small gifts up to the value of £250 to as many people as you like in any one tax year
  • Potentially Exempt Transfers – any gifts you make to individuals will be exempt from Inheritance Tax as long as you live for seven years after making the gift.  These sorts of gifts are known as ‘potentially exempt transfers’.  Remember that if you give an asset away but keep an interest in it – for example you give your house away but continue to live in it rent-free – this gift will not be a potentially exempt transfer.

3 Things Everyone Should Do Before The Tax Year Ends

The current tax year ends on 5 April 2011.  With changes to personal allowances and tax scheduled to come into effect in just a matter of weeks, there are several steps you can take now to minimise the amount of income tax that you pay.

Our guide suggests three things you should do before 5 April.

Budget for the new tax regime

With several important changes coming into effect on 6 April, it is vital that you budget for the impending tax hikes and benefit cuts.  Suggestions include:

  • Budgeting for the National Insurance rise of 1 per cent
  • Allowing for cuts to working and child tax credit (particularly for households with income over £40,000 or families with a child under the age of one)
  • Preparing for the fall in Winter Fuel Allowance
  • Preparing for the three year freeze in Child Benefit

Contribute to an Individual Savings Account (ISA)

Individual Savings Accounts offer tax-free savings to everyone.  That means that you can receive interest on your savings without any income tax being deducted.

So, if you haven’t contributed to an ISA in the tax year 2010/11 you have until April 5th to do so.  The maximum that you can contribute to a cash ISA before 5 April is £5,100.  However, if you want to invest in a ‘stocks and shares ISA’ you double your allowance to £10,200.

Of course, you can maximise your tax free savings each year.  After 6 April 2011 you will be able to contribute a further £5,340 to a cash ISA or £10,680 to a ‘stocks and shares’ ISA.

Use up your tax allowances

Our final piece of advice is to use up any other tax exemptions such as your capital gains tax (CGT) and inheritance tax (IHT) allowances.

You are allowed to make capital gains of £10,100 this tax year without paying any tax.  So, you may want to consider selling some assets (such as shares, for example) in order to maximise your CGT allowance.

And, if you have a large estate and are worried about Inheritance Tax, you are permitted to give away up to £3,000 tax free each tax year.  You can carry over any unused IHT allowance from the previous tax year and so if you have never made any such gifts, you could potentially gift up to £6,000 before 5 April 2011.

Bear in mind that there is also an IHT ’small gifts exemption’.  This means that gifts of £250 are also free of IHT.  Although there is no restriction on the number of small gifts that you can make, they must each be to separate individuals (for example you cannot combine the ‘small gifts exemption’ with the annual exemption to give someone £3,250.)

7 Things You Should Know About Giving Your Home To Your Children

Do you want to gift your home to your children?

You are permitted to give your home to your children (or another beneficiary) at any time – even if you live in it.  However, if your home and your estate are worth more than the Inheritance Tax threshold (£325,000 in tax year 2010/11) there may well be tax implications.

Our guide outlines seven things you should know when considering giving your home to your children.

Seven-year rule

Giving your home away is treated (for Inheritance Tax purposes) as ‘making a gift’.  When passing on property, there are two things that you should be aware of.  The first is the ‘seven year rule’.

You can make an outright gift of your home to someone, irrespective of its value, and it will be exempt from Inheritance Tax if you live for seven years after making the gift.  This is known as a ‘potentially exempt transfer’ (PET).

Gifts that you continue to benefit from

The second important thing to be aware of is the idea of a ‘gift with reservation of benefit’.

If you give your home to your children with conditions attached to it, or if you continue to benefit from the home yourself, this is known as a ‘gift with reservation of benefit’.  In this case, the gift won’t be exempt from Inheritance Tax, even if you live for seven years afterwards.

Giving your home to your children and moving out of it

As we have seen above, you cannot gift your home and then continue to live in it without it remaining part of your estate.  You are permitted to make visits and to stay for short periods in the home that you gift, but you cannot remain permanently.

Giving your home to your children and continuing to live in it

If you gift your home to your children, you can continue to live in it as your main residence as long as you pay a market rent to the new owner.  You should bear in mind that the new owner may have to pay Income Tax on the rent you pay them.

If you don’t pay a market rent, the gift will be considered a ‘gift with reservation of benefit’ and the house may be subject to Inheritance Tax.

Selling your home and giving the proceeds to your children

Instead of gifting the property to your children, you could sell your home and gift them the proceeds from the sale.  In this case, the gift won’t be included in your estate for Inheritance Tax purposes, as long as you live for seven years after you make the gift.

However, if you sell your home, give the money to your children and then move into their home, there could be Income Tax implications.  You may be classed as ‘living in a pre-owned asset’ if you do not pay the market rent.

Gifting your home to your children who then move in with you

If you give your home to your children and they then move in with you, the gift will be treated as a ‘gift with reservation of benefit’ and the home will still be subject to Inheritance Tax.

However, if you give half of your home to your children, they move in with you and you share bills jointly, the half that you give them won’t be treated as part of your estate for Inheritance Tax purposes as long as you live for seven years after making the gift.

Capital Gains Tax on a home you gift to your children

As long as the home you give away is your main home, Capital Gains Tax won’t be payable.

However, if you give away a second home, Capital Gains Tax may be payable if the property has increased in value between when you first owned it and when you gave it away.

Inheritance Tax – 4 Gifts That Are Exempt

Is your estate worth more than the Inheritance Tax threshold?

If your estate is worth more than £325,000 (in tax year 2010/11) then you may find you have an Inheritance Tax (IHT) liability.  So, it is important that you make the most of the exemptions during your lifetime that allow you to make gifts to other people and not have to pay tax on them when you die.

Here are four gifts that are exempt from Inheritance Tax.

Annual Exemption

One of the easiest ways to avoid Inheritance Tax is to give away gifts during your lifetime.  You are able to give away gifts up to the value of £3,000 in each tax year and these gifts will be exempt from IHT when you die.

In addition, you can carry forward any unused part of your annual £3,000 allowance to the following tax year.

Gifts to ‘exempt beneficiaries’

It is possible to make gifts to certain people and organisations either during your lifetime or in your will.  You won’t pay any IHT on ‘exempt gifts’ to:

  • A qualifying charity
  • Your wife, husband or civil partner (as long as they have a permanent home in the UK)
  • National institutions such as the National Trust, museums and universities
  • A recognised UK political party

Remember that any gifts you make to a partner that you are not married to (or in a registered civil partnership with) are not exempt.

Small Gifts

You are also able to make small gifts up to the value of £250 to as many people as you like.  You can’t use the ‘small gifts’ exemption in addition to another exemption when giving to the same person, and you can’t give a more valuable gift and claim for the first £250.

Potentially Exempt Transfers

It is possible to gift anything to an individual and not pay any Inheritance Tax as long as you live for seven years after making the gift.  These are called ‘potentially exempt transfers’.

If you make a gift and then die within seven years, and the gift is valued at more than the IHT threshold, you or your estate will have to pay Inheritance Tax.  If you die within seven years and the total value of gifts is lower than the IHT threshold, the value of the gifts is added to the total value of your estate.  Any IHT due will have to be paid.

The rules for ‘potentially exempt transfers’ can be quite complicated.  For example, if you gift your home to your children but keep living there rent-free, the gift may not be ‘potentially exempt’.

If you die between three and seven years after making a gift, any Inheritance Tax due on that gift is reduced on a sliding scale under an exemption known as ‘Taper Relief’.

How To Transfer An Inheritance Tax Threshold To A Spouse Or Civil Partner

Inheritance Tax (IHT) has been payable in the UK since 1796.  However, in recent years there have been many changes to the rules surrounding the liability for this tax.  Changes to the law in October 2007 made it possible to transfer any unused inheritance tax threshold from a late civil partner or spouse to the second civil partner or spouse when they die.

Our guide explains how you transfer an unused IHT threshold.

The inheritance tax ‘nil rate band’

Every individual in the UK has an inheritance tax ‘nil rate band’.  This is the amount that your estate can be valued at before you have to pay any IHT.  In the tax year 2010/11 this threshold is £325,000.

Married couples and registered civil partners are also allowed to pass assets from one spouse or civil partner to the other during their lifetime or when they die without having to pay inheritance tax.  HMRC call this ‘spouse or civil partner exemption’ and there is no IHT due, irrespective of the value of the assets that are passed on.

The person receiving the assets must have their permanent home in the UK.

Transferring the nil rate band

If a deceased person leaves their estate to their spouse or civil partner, it has two advantages.  Firstly, no IHT is payable on their death.  Secondly, it also means that they have not used any of their own IHT ‘nil rate band’.

It is then possible to increase the IHT ‘nil rate band’ of the second spouse/civil partner when they die.  This means that their estate can be worth up to £650,000 in tax year 2010/11 before any IHT is due.

To transfer the unused threshold, the executors or personal representatives of the second spouse or civil partner to die, need to send certain forms and supporting documents to HM Revenue & Customs (HMRC). HMRC calls this ‘transferring the nil rate band’ from one partner to another.

When can the ‘nil rate band’ be transferred?

The ‘nil rate band’ can only be transferred on the second death, which must have occurred on or after 9 October 2007.

How to transfer the ‘nil rate band’

The transfer should be applied for by the executors or personal representatives of the deceased person’s estate.

Firstly, you have to work out what portion of the ‘nil rate band’ you can transfer.  If the whole estate was all left to the surviving spouse or civil partner, you can transfer the full percentage when the second spouse or civil partner dies.  However, if the deceased person made non-exempt gifts during their lifetime, the proportion of the ‘nil rate band’ that can be transferred may be lower.

You will then have to submit some documents and supporting information to HMRC, including:

  • A copy of any will
  • A copy of the grant of probate or death certificate

You will then need to complete HMRC form IHT402 to claim the unused ‘nil rate band’ and return this with HMRC form IHT400 and the supporting documentation.

You must make the claim within two years from the end of the month in which the second spouse or civil partner dies.

The Number One Secret Of Inheritance Tax Planning

Inheritance Tax (IHT) nets the Government just under £3 billion in revenue every year.  Despite this huge tax bill, Brits are becoming increasingly aware of IHT and the methods that can be employed to avoid it.  In 2009, tax officials told the Guardian that they expected the number of households paying Inheritance Tax to be at its lowest level since 1938.

There are lots of ways that you can reduce the amount of IHT that you pay.  However, the simplest and easiest way to begin your inheritance tax planning is to make a will.

Why you should make a will

As well as helping you to reduce the amount of inheritance tax that is due, there are various other important reasons why you should make a will:

  • You can decide how you want your assets to be shared out.  If you do not make a will, the law decides where your assets go and this might not suit your wishes
  • If you are not married or in a civil partnership, your partner will not automatically inherit your assets.  A will makes sure that your partner is provided for
  • if you are divorced or if your civil partnership has been dissolved you can decide whether to leave anything to an ex-partner who is living with someone else

Using your will to leave your assets to your wife, husband or civil partner

In this situation, there will typically be no IHT to pay.  A husband, wife or civil partner counts as an ‘exempt beneficiary’, meaning that you can leave assets to them in a will without paying any inheritance tax.  It’s a simple way and effective way of inheritance tax planning.

It is worth remembering, however, that if you leave all your assets to your spouse or civil partner, their estate will be worth more.  There may therefore be more IHT to pay when they die.

One exclusion to this rule applies if you are domiciled (have your permanent home) in the UK when you die but your spouse or civil partner isn’t. In this situation, you can only leave them £55,000 tax-free.

Using your will to leave your assets to other beneficiaries

In the tax year 2010/11 you are able to leave up to £325,000 tax free to anyone in your will.  £325,000 is the current IHT threshold over which tax is due.

In this situation you can use your will to give some of your estate to someone else or to a family trust. Inheritance Tax is then payable at 40 per cent on any amount you leave above the threshold.

Using your will to leave your assets to a UK charity

Inheritance Tax is not payable on any money or assets you leave to a registered UK charity.  These transfers are exempt.

£99Tax Returns Online