Inheritance Tax Planning (ITP)

The Fantastic Funeral Company has access to professional expertise concerning all aspects of ITP. We have provided some basic, generic information below, but please contact us to discuss your individual requirements.

The law currently allows you to leave an estate worth up to £285,000 (as at April 2006) without any Inheritance Tax charge falling upon it. This £285,000 is called the 'Nil Rate Band'. After the Nil Rate Band, the remainder of your chargeable estate will be charged 40% Inheritance Tax.

Inheritance Tax (IHT) is becoming an important consideration for an increasing number of taxpayers. As a result of spiraling property values, the family home is often a major factor in many people falling into the IHT 'net' for the first time. This highlights some basic IHT principles as an initial reference point.

The scope of IHT

An individual who is domiciled in the UK is liable to IHT on chargeable property on a worldwide basis. A non-UK domiciled individual is also liable to IHT, but only on chargeable property in the UK.

Domicile for IHT purposes

In addition to the legal concept of domicile, for IHT purposes an individual can be deemed domiciled in the UK if he or she was UK domiciled at any time in the 3 years immediately preceding the time at which the question of domicile is to be decided, or alternatively UK resident for at least 17 out of the last 20 years ending with the tax year in which a chargeable event takes place.

What is a 'Chargeable transfer'?

IHT is levied on chargeable transfers made during an individual's lifetime, and on the value of his or her death estate. A 'chargeable transfer' is a transfer of value made by an individual, other than an exempt transfer.

Inter-spouse transfers

Perhaps the most well known and commonly used exemption is for gifts between spouses, although it should be noted that if, immediately before the gift, the transferor but not the transferee spouse is domiciled in the UK the exemption is limited to a gross cumulative total of £55,000. The spouse exemption applies to both lifetime transfers and transfers on death.

Leaving assets to your spouse can compound the effect of Inheritance Tax. We have explored these points further in the sections on Wills and Joint Assets below.

Other exempt transfers

There are various IHT exemptions for lifetime transfers. The annual exemption allows individuals to make gifts of up to £3,000 per tax year in total. Any unused exemption may be carried forward, and added to the annual exemption for the following year only. Other lifetime exemptions include a 'small gifts' exemption, an exemption for certain gifts in consideration of marriage and an exemption for normal expenditure out of income if certain conditions are satisfied.
Potentially Exempt Transfers (PETs)

A PET is a lifetime transfer of value which would otherwise be a chargeable transfer, and is a gift to an individual or certain types of trust, i.e. a simple bare trust where all beneficiaries are aged over 18 or a trust which qualifies as a trust for a disabled beneficiary. A PET made 7 years or more before the transferor's death is exempt for IHT purposes. Otherwise, the PET is a chargeable transfer.

Chargeable Lifetime Transfers

A chargeable lifetime transfer is a transfer of value made by an individual, and which is not (potentially or otherwise) an exempt transfer, e.g. transfers into most forms of trust. If the donor agrees to bear the IHT liability, the tax further reduces the value of the estate. The transfer is therefore 'grossed up' on a tax-inclusive basis to arrive at the chargeable transfer.

How is IHT calculated on chargeable lifetime transfers?

Chargeable transfers are taken into account on a cumulative basis. The transfers are aggregated over a 7-year period, after which they fall out of the cumulative total. The amount of IHT on the latest transfer is determined by reference to this total. Tax is charged at half the IHT rate on death (i.e. at a 'lifetime rate' of 20% for 2006/07), to the extent that the 'nil rate band' (i.e. £285,000 for 2006/07) is exceeded, after deducting annual exemptions etc.How is IHT calculated on the death estate?

If an individual dies within 7 years of making a chargeable lifetime transfer, IHT is recalculated at the full 'death rate' on the transfer (i.e. 40% for 2006/07), subject to 'taper relief' if the death is more than 3 years after the gift. In addition, the individual is treated as making a notional transfer of the whole estate immediately prior to death, and IHT is charged accordingly.

Where there's a Will...

A Will helps to ensure that a person's death estate passes in accordance with their wishes, rather than under the law governing intestacy. A deceased individual's estate (under a Will or the laws of intestacy) may be varied (or alternatively disclaimed) following death. For IHT purposes, a variation is treated as if made by the deceased. A written deed of variation must be made within 2 years of the death.

If you are a married couple, one of the simplest and most effective ways of avoiding some Inheritance Tax, is simply to take advantage of two Nil Rate Bands. For example:

If Mr. & Mrs. Smith have a joint estate worth £600,000, they may upon the death of the first spouse give away to their beneficiaries £285,000 without having to pay Inheritance Tax, thereby utilizing a Nil Rate Band. However, if they do not do this and simply pass the estate to the remaining spouse, when the estate is eventually split it will only be allowed a single Nil Rate Band, rather than the two which could have been used.

1. Using only 1 Nil Rate Band:

Mr. & Mrs. Smith have £600,000. Upon the death of first spouse, all the money is left to the remaining spouse without using the Nil Rate Band. Upon the death of the remaining spouse, only the one Nil Rate Band of £285,000 will be allowed, leaving an estate of £315,000 liable to Inheritance Tax at 40%, resulting in Inheritance Tax of £126,000.

2. Using 2 Nil Rate Bands:

Mr. & Mrs. Smith have £600,000 upon the death of the first spouse £285,000 is given away free of Inheritance Tax using the Nil Rate Band, leaving £315,000 to the second spouse. Upon the death of the second spouse, another £285,000 will be allowed free of Inheritance Tax using the Nil Rate Band, leaving only £30,000 liable to Inheritance Tax at 40%, resulting in Inheritance Tax of £12,000.

However, this approach could leave the surviving spouse with insufficient financial resources. One solution is for each spouse to establish a Nil Rate Band Discretionary Trust. Under this arrangement funds equal to the deceased spouses Nil Rate Band are passed into a form of trust which potentially enables the trustees to distribute capital or income from the trust to the surviving spouse if necessary.

However, this could leave the surviving spouse in a difficult financial position with not enough capital to generate the income they require. The solution is for each spouse to establish a Nil Rate Band Discretionary Trust which allows for the surviving spouse to gain access to funds if necessary. An amount equal to the Nil Rate Band on death is placed in a trust fund and income is paid to the surviving spouse. The spouse is also entitled to whatever capital is needed out of the trust.

Joint assets

Often the largest asset owned is the family home. Husbands and wives are usually, but not always, "joint tenants". Joint assets pass directly to the surviving joint tenant (i.e. the surviving spouse) and do not pass under the Will. These joint assets cannot be used to fund the Discretionary Trust Fund. However, where the property is held as "tenants in common" either party may make a gift in a Will of his or her share of the property.

It is therefore worthwhile considering "severing" the joint tenancy in the house, and each party giving his or her share in the house to the children with the right for the surviving spouse to live in the property until his or her death. Although the property would still be owned jointly with the spouse, the significant difference is that on the death of the first spouse the 50% share owned by them can then be used towards satisfying the Nil Rate Band Discretionary Trusts.

Important Note

The above is based on our understanding of tax legislation and Inland Revenue practice as at the time of writing, January 2007. Both this legislation and Inland Revenue practice may subsequently change. Whilst every care has been taken in its production, no responsibility can be accepted for any action undertaken or refrained from as a consequence of this material. This information is for general guidance only and you should not act upon it without taking professional advice which is based on your specific personal circumstances. We accept no responsibility whatsoever for any action undertaken or refrained from as a result of the information contained herein.

Other Ways to reduce Inheritance Tax

It is possible to reduce Inheritance Tax by holding assets which become exempt from Inheritance Tax if they are held for a minimum qualifying period generally of 2 years before death or transfer. Two examples are:

1. Holding shares which qualify for Business Property Relief, including Enterprise Investment Schemes and shares in some companies listed on the Alternative Investment Market. Certain specialist investment managers offer portfolio management services which are designed to qualify for exemption on this basis.

2. Investing in assets which qualify for Agricultural Property Relief, for example commercial forestry or farming (including under certain conditions farmland). Again there are specialist investment managers which offer collective investment schemes which are designed to qualify for exemption.

A number of insurance companies and other investment managers also offer various trust based packaged arrangements which are designed to achieve some degree of Inheritance Tax reduction whilst also enabling the investor to retain access to some degree of capital and/or income.

We strongly recommend that any interested party seeks Independent Advice from a professionally qualified Financial Adviser and/or Solicitor, particularly one who is also a member of the Society of Trust and Estate Practitioners (identified by use of the designation TEP on their business stationery) before entering into any arrangement to mitigate Inheritance Tax.

If you would like us to do so, we are able to introduce you to a Chartered Accountant who is also a very well qualified Independent Financial Adviser, Chartered Financial Planner, Certified Financial Planner and Member of the Society of Trust & Estate Practitioners. He is a specialist elderly client adviser who is also authorised to advice on Care Fees Planning. He will generally offer our clients an initial overview free of charge and from then on agree a fixed fee for any work to be undertaken.

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Please email The Fantastic Funeral Company here, or telephone us on 0113 269 7892.