How to Reduce Inheritance Tax
Are there legitimate things I can do to avoid Inheritance Tax?
Former Chancellor of the Exchequer, Roy Jenkins, once said, “Inheritance Tax is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”! Whilst the rules have been tightened-up somewhat since he said this, there are certainly many things that can legitimately be done to reduce the burden of Inheritance Tax.
Often, Clients approach me worried about the impact Inheritance Tax (IHT) might have on their family’s eventual inheritance. However, with the 2023/24 threshold at £325,000 for an individual and £650,000 for a couple, this is not an issue for very many people. Especially now that this can be increased by up to £175,000 per individual and £350,000 per couple with the Residential Nil Rate Band. In fact, in 2020/21, only 3.73% of estates dealt with by Probate Registries resulted in any Inheritance Tax being payable, which has main broadly the same sine 2016/17 (Source: HMRC 31 July 2023).
What are the best ways to reduce my Inheritance Tax bill or that of my heirs?
In how Inheritance Tax works, I discuss the Inheritance Tax Allowances and Exemptions and exploiting these is the very best way of reducing your Inheritance Tax bill.
If you have a life-expectancy of at least 7-years and you can afford it, the most obvious way to reduce your Inheritance Tax bill is to give away some of your assets. There is no tax on you or the Donee at the time of the gift, regardless of the amount, but the gift, known as a Potentially Exempt Transfer (PET), will be brought back into account for Inheritance Tax if the you die within 7-years.
If you don’t want to make an absolute gift, or it is inappropriate because of age, disability or family reasons, then wrapping the gift in a Trust can be just as effective. Putting money into most Trusts is not a PET but a Chargeable Lifetime Transfer and liable to Inheritance Tax at the lifetime rate of 20% if the amount put into Trust exceeds £325,000 per individual. Professional advice should always be taken before setting-up a Trust, so it is inappropriate to go into further detail here.
In Inheritance Tax & Gifts, I discuss the point that a gift has to be absolute – giving-up all rights to the asset given away – to avoid being caught by the rules governing Gifts with Reservation of Benefit. However, there are a number of legitimate schemes that provide an element of “cake and eat it” by exploiting a legal device known as a carve-out, which was established in St. Aubyn v Attorney General [1952] and has stood the test of time.
For example, the right to a future income can be “carved-out” before an asset is put into Trust and this does not fall foul of the reservation rules. As this type of planning involves the use of Trusts, professional advice should be sought.
If you have a life-expectancy of less than 7-years, but more than 2-years, then exploiting Business Relief is worth considering. By acquiring assets eligible for Business Property Relief and holding them for a minimum of 2-years, they are then effectively valued a nil for Inheritance Tax purposes. Access to the asset and/or any income generated is not restricted in any way.
There does, however, need to be an element of “enterprise” involved because this is the basis of the exemption, so there is invariably a higher degree of investment risk involved. I was taught many years ago to never allow the “tax tail to wag the investment dog” and this is very relevant in this context. Again, this is an area where relevant professional advice should always be sought.
What about tax evasion? How can I avoid falling into this trap?
Here we enter the debate about the difference between tax avoidance and tax evasion and is something that is very topical following various high profile exposés, especially the comedian, Jimmy Carr. Let’s be frank, tax evasion always has been and always will be illegal and, consequently, is something that I never have been and never will be involved in.
Generally, tax avoidance, where that is merely the legitimate exploitation of allowances and exemptions written into the legislation, is not only legal and legitimate, it is something the Government expects us to do (and is what Roy Jenkins meant). I use the word “generally”, because a whole industry has grown up around the exploitation of tax allowances and exemptions, resulting in schemes which, at best, tread a thin dividing line between avoidance and evasion.
Such schemes have caused the Treasury so much concern that the Government has introduced DOTAS (Disclosure of Tax Avoidance Schemes). Under this legislation many schemes, including those involving Inheritance Tax, have to be disclosed to HMRC, allowing them to find ways of “closing the loophole”. Widening this process has lead the Government to introduce GAARs (General Anti Abuse Rules), which are used effectively in other countries.
So, I would answer the questions by saying it’s by avoiding anything that is not a straightforward exploitation of the allowances and exemptions. If it seems to be too good to be true, it probably is!
If there is one asset that people want to protect from Inheritance Tax, it is their home. However, it is virtually impossible to lift this asset out of the net of Inheritance Tax whilst still living in it and not offend the rules governing Gifts with Reservation of Benefit. A “Double Trust” scheme was marketed by a number of professional advisers a number of years ago and the Government enacted what was effectively retrospective legislation to defeat this.
If you give your home away you need to remember this is exactly what you have done – given it away. What happens if the person you give it to goes bankrupt, gets divorced or dies? Also, there is the issue of the loss of Principal Private Residence relief from Capital Gains Tax on a subsequent disposal. For the gift to be effective for Inheritance Tax purposes, you would have to pay a commercial rent to your Children/Grandchildren for the rest of your life. After I’ve said that to a Client, the next words I often hear are, “That’s alright; they’ll just give it straight back”. Surprise, surprise, that’s tax evasion!
The bottom line here is, take professional advice.
Naturally, as a Registered Trust & Estate Practitioner and a Chartered & Certified Financial Planner, I advise on all aspects of IHT planning, including the drawing-up of suitable Wills and Trusts, so talk to me today if you think you have a problem and need a solution or complete the form below.
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0800 074 8755info@clivebarwell.co.uk