With a general election expected to take place within the next 18 months, we take a look at the current UK Inheritance Tax (IHT) landscape and answer some of the most commonly asked client questions.
Although IHT is far from the highest earner for the Exchequer, HMRC did have a record-breaking haul of IHT receipts in 2021/22, where £7.1bn was raised. So, it’s expected that IHT will be front and centre of both Rishi Sunak’s and Sir Keir Starmer’s next election manifestos.
What exactly is IHT?
Well, UK IHT is a tax levied on death and charged on an individual’s worldwide estate (property, money, and possessions), where they are domiciled in the UK. IHT can also be applied to some lifetime gifts – generally, where an individual creates a trust.
It’s also important to note that IHT can apply to non-UK domiciled persons, but only to the extent they have ‛UK situs assets’ i.e., assets situated in the UK. (This article does not consider domicile in any detail and professional advice should be sought where you are unsure of your domicile status.)
Based on current tax rates, UK IHT is charged at 40% — a rather hefty tax charge bearing in mind you’ll have already paid tax (in some form or another) on the assets held in your estate over the course of your lifetime.
Does everyone have to pay IHT?
You only pay IHT on the value of your estate where it exceeds a certain threshold known as the ‛nil-rate band’. This is currently set at £325,000 for individuals, or £650,000 for married couples and civil partners.
Additionally, there is the ‛residence nil-rate band’ (RNRB), an additional allowance, specifically designed to protect the value of a family home where it is gifted to your children or grandchildren. As of 2021, this allowance has been fixed at £175,000 per individual, increasing the total potential tax-free threshold. Like the nil-rate band, this allowance can also be transferred between spouses or civil partners, potentially enabling them to benefit from a combined RNRB of £350,000. As a result, spouses or civil partners can avoid paying any UK IHT where their estate is below or equal to £1 million.
Are there any tax reliefs that can reduce my IHT liabilities?
Alongside the two nil-rate bands, there are several IHT reliefs available to taxpayers that can reduce your IHT exposure on death. The most common reliefs are outlined briefly below:
Spouse or Civil Partner Exemption — one of the most significant tax reliefs available is the spouse or civil partner exemption. Assets transferred to a surviving spouse or civil partner are not subject to IHT, regardless of their value[1]. This relief ensures that the estate’s value can be passed on entirely to the surviving partner without incurring any tax liability.
Business Property Relief (BPR) — for individuals with interests in qualifying business assets, BPR provides relief from IHT. If specific criteria are met, such as owning a sole trade business, business assets, or shares in an unquoted trading company, relief can be claimed at 100% on the value of the assets.
Agricultural Property Relief (APR) — like BPR, APR provides relief from IHT on the agricultural value of land and buildings. This relief is important for individuals involved in agricultural activities, helping to protect farming assets from substantial tax liabilities and enabling them to pass on the farming business to the next generation IHT free.
Although, the relief is limited to the ‛agricultural value’ of assets, typically farming enterprises will also qualify for BPR meaning IHT can be avoided on death — this can be important where farmland has ‛developmental value’.
The farming industry has been a particular focus for HMRC, with many farmers looking to diversify into other areas, such as short-term holiday lettings, retail of farm produce, and renewable energy generation. Though these ventures can be lucrative from a financial perspective, they can have adverse tax consequences for IHT purposes and could potentially jeopardise APR and BPR claims on death. Careful planning is required here.
How can I reduce my IHT exposure now?
While everyone’s circumstances will be unique, there are several simple ways you can mitigate your IHT exposure. Here are some of our top tips:
Lifetime gifting — this may sound simple, but giving away assets during your lifetime can be one of the most efficient ways to save IHT on death. For instance, individuals can gift away any value of assets free of UK IHT, as long as they survive 7 years from the date of the gift.
What’s more, taxpayers can give away significant chunks of their earnings to beneficiaries as long as they can prove it does not impact their standard of living. Although lifetime giving is a very effective way to reduce IHT, you should seek professional advice before giving away any significant assets.
Holding IHT efficient assets — investing in IHT friendly assets can also reduce your IHT exposure. Other than farms and trading businesses, some other assets that qualify for BPR include, AIM listed stocks, shares qualifying under the (Seed) Enterprise Investment Scheme, and owning commercial woodlands.
Creation of IHT efficient vehicles — although these vehicles generally require some element of lifetime gifting, trusts and/or Family Investment Companies (FIC) can be efficient structures from an IHT perspective. However, trusts and FIC are complex to setup and administer — so ensure you seek advice to avoid any pitfalls.
- Donate to charity — gifts to charity are tax exempt, and if you leave at least 10% of your net estate to charity, the rate of IHT is reduced to 36%.
- Spend your money — you only live once. So, the simplest way to reduce your IHT exposure is to spend your money, treat yourself. Why not go on the holiday of a lifetime or get that new car that you have always been dreaming of?
Lastly, granted this is not an IHT mitigation strategy, life insurance can be a great way of preserving your estate by providing cover for any potential IHT bills that may arise. Life insurance is generally not subject to IHT either, as long as it’s held in a trust structure, which is the norm these days. Also, depending on your circumstances, life insurance premiums can be quite reasonable in comparison to a significant IHT bill on death.
As Mark Twain once said, ‟Nothing is certain except for death and taxes”. However, with careful planning, the tax payable on death can be mitigated.
If you have an Inheritance Tax query, contact myself or one of the Personal Tax Team for a chat.
Author: Joe McKillion, CT: Personal Tax
[1] There are special rules for non-domiciled individuals.
