Making sense of the labyrinth of inheritance tax

According to official data, inheritance tax payments hit a record high in the last tax year, breaking the £5bn mark for the first time.

As the Telegraph reports,over 5% of estates were liable for inheritance tax in 2017-18. This has risen from 2010-11 when less than 3% of estates were liable and paid a total of £2.7bn.

This increase in the amount paid in inheritance tax is due to a combination of a static inheritance tax threshold and soaring house prices. These factors mean middle-earners who might not have prepared financially are also having to pay death duties.

While numerous reviews into inheritance tax legislation are being conducted, the landscape remains a bewildering labyrinth of regulations. But it pays for individuals to start making sense of it and planning for inheritance tax now.

How it works

The current inheritance tax threshold is £325,000 per person. However, married couples and civil partners have no limit on the amount of assets they pass to each other when one of them dies. Their threshold also doubles, so a wife who outlives her husband can pass on £650,000 to her children, tax-free, when she dies, if her husband left his entire estate to her. Any money or assets above the thresholds will be taxed at 40%.

In 2017, an additional allowance for the family home was introduced. By 2020, a married couple will be able to leave £1m tax-free to their children thanks to the “residence nil-rate band”.

Gifting allowances complicate matters even further. As BBC News explains, giving first can help to reduce the final estate value. You are entitled to give away £3,000 in tax-free gifts every year. If you choose to gift a larger sum of money, this will need to be transferred at least seven years before you die, as it will stay in your estate valuation for this period. If you don’t survive for that long, the amount payable will be scaled down for each year you live, the Telegraph explains.

Reduced rates are also applicable for those who give a proportion of their estate to charity.

But what if you have other assets you need to think about?

Passing on buy-to-let portfolio

The residence nil-rate band only applies to family homes so any buy-to-lets will be included in the usual threshold. This means that just £325,000 worth of property will be able to be passed on tax-free. Inheritance tax will, therefore, be payable on the whole portfolio that falls above the threshold.

According to Julia Rosenbloom from Smith & Williamson, gifting is the easiest way to avoid paying. However, as previously mentioned, these payments will need to be paid seven years before you die.

Other things to consider beyond death duties are potential capital gains tax, if the properties have risen in value since the purchase date, and portfolios with outstanding mortgages could face stamp duty if they are gifted.

Passing on a holiday home

If you wish to pass on your holiday home to your children, many of the same considerations of gifting, stamp duty, and capital gains tax will apply. But there may also be overseas tax liabilities. Spain, for example, has various regional differences on the amount of inheritance tax a non-resident has to pay on Spanish assets.

Passing on a family business

While family businesses can benefit from gifting, many will be exempt from death duty, even if they have been passed on in a will.

Business property relief means family-owned small businesses, or shares in similar companies, are eligible for 100% relief from inheritance tax. It is possible to get full relief on a business, or shares in an unlisted company, while 50% relief is available for some shares, as well as machinery, land, or buildings used for business.

No limit exists on the value of businesses eligible for relief but some will be excluded, including those dealing in securities, stocks or shares, and non-profits. Businesses must also be trading and capital gains tax could still be applicable.

Inheritance tax can be a confusing maze of legislation and it can seem even more complex when a small family-owned business is involved. We help connect business owners needing both corporate and personal financial advice with financial advisers who can provide clarity and guidance on these matters.

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