The Problem
Britannia: Inland Revenue Office
Inheritance tax is calculated on the total of a person’s estate, including their property.
And therein lies the problem.
With house prices rocketing, more and more middle income families, particularly in London and the South East, have been finding themselves liable for a tax that was designed for the wealthy.
Research from the Halifax reveals that:
• In 2006/07, 33,000 estates are estimated to have paid inheritance tax, while in 1997/98 only 18,000 estates paid the tax.
• Inheritance tax revenue raised in 2006/07 was a record £3.6bn, up £300m (nine per cent) on 2005/06 when £3.3bn was collected.
• UK property taxes, including IHT, make up 12 per cent of our total taxes. This compares with an average of 5.3 per cent in the Euro-Zone and 2.5 per cent in Germany.
Darling's Solution
Previously if a couple owned an estate worth over £300,000, the taxman could relieve their heirs of 40 per cent of the excess in inheritance tax (IHT).
But under the new rules, the IHT tax threshold will now be transferable between partners.
This effectively means, for many, a doubling of the allowance, so that married or civil partnership couples, and widows and widowers, will only pay IHT on an estate of over £600,000, rising to £700,000 in 2010.
According to the Halifax, this should keep an extra 2.4 million properties out of the IHT net, leaving a mere 600,000, or three per cent of owner-occupied properties in the UK over the threshold.
And, the Government promises, it will consider both house prices and retail price inflation when setting IHT thresholds in the future.
A Real Change?
In reality, as the 40 per cent or so of people who have sought advice on minimizing IHT liabilities already knew, it was always possible to stretch a couple’s threshold to £600,000.
With careful drafting of wills, and by changing your home ownership to make a couple tenants in common, an estate could, effectively be split in half, allowing both partners to take advantage of an individual nil tax band.
Carolyn Steppler, tax director at KPMG in the UK, comments: "This change, although likely to grab headlines, is in practice only giving to most people what they already have."
What About Singletons & Divorcees?
But perhaps more serious is the criticism that the changes will not apply to single people or divorcees and their families who will still be stuck on the £300,000 threshold.
Even if a single person’s property doesn’t fall within the individual nil tax band (unlikely if they live in London and need enough space for a family), once the value of other assets such as life cover, savings and cars are included they may be pushed into the 40 per cent tax zone.
Carolyn Steppler says: "It is very disappointing to note that the proposals will not benefit unmarried or non-Civil Partnership couples, or siblings who have lived together as in the recent case of the elderly Burden sisters.
"They had lived together all their lives before one sister faced having to sell the house in her eighties when her sister died."
How To Reduce Your Liability
You can legally reduce your IHT liability in various ways, but the rules can be complicated, and it is important to seek professional advice, but here is a rough guide.
1. Give It Away
Any gifts you make more than seven years before your death are usually exempt from IHT. But there are other gifts that you can give at any time that are tax free.
For example, wedding presents and gifts in anticipation of a civil partnership worth up to £5,000 are exempt, as are gifts to charity, political parties and national institutions.
In addition, each individual can give away lump sums of up to £3,000 per year as their ‘annual exemption’, and small gifts, up to the value of £250, can also be given to as many people as you like in any one tax year.
2. Downsize To A Smaller Property
It is likely that your property will be your main asset, and it may look like a good idea to sell up and pass on the proceeds.
But if you die within seven years your heirs would have to pay IHT on the amount they received if your estate is over the threshold.
However, you could give the money away in £3,000 chunks (£6,000 if you are a couple) each year as part of your annual exemption.
3. Gift Your Property
Transferring ownership of your property to your beneficiaries, while you continue living in it, also known as ‘gifting’, used to be a good way to reduce your IHT liabilities.
But the Government has now cracked down on this and even if you live for more than seven years after making the gift, the property will count as part of your estate and will therefore be liable for IHT.
Gifting a house is classified by the Inland Revenue as a gift with ‘reservation of benefit’, and your beneficiaries would be liable for IHT unless they could prove that you had paid them a genuine market rent to live there.
Realistic rents may be beyond the means of most pensioners, and your heirs should be aware that any rent they receive from you would be treated as taxable income.
There are other major pitfalls with gifting your home. If your relationship with your heirs breaks down, or if they becomes bankrupt or get divorced the property, your home, could be sold from under you.
Also, if they sell the property, and it is not their main home, they would be liable for Capital Gains Tax on any increase in its value.Get Advice
According to recent research from Bradford & Bingley, 61 per cent of Britons are failing to seek advice about how to minimise their IHT liabilities.
For those fortunate enough to have estates worth more than the IHT threshold a professional advisor would be able to find the right method of reducing any tax burden on your heirs.
Andrew Stead, Head of Wealth at Bradford & Bingley, says: "While it's no surprise that planning for death is not at the top of most Britons' to-do list, by seeking advice about how to mitigate against IHT and planning their finances in a tax-efficient way, people can protect their hard-earned assets and protect their families from the burden of financial uncertainty in the future."
Nikki Sheehan