In his Budget earlier this month the Chancellor announced that the inheritance tax (IHT) nil rate bands are being frozen for another five years. With surging deaths related to the coronavirus coupled with a booming housing market, the freeze is set to push the so-called death tax takings to an all-time high with thousands more people paying IHT. Some experts have speculated that this may even bring the annual haul to £6.6bn by 2026, up from £5.1bn last year! These are no doubt scary figures and with that in mind, this article will look at what the situation is today in relation to IHT, where the Budget has left the system, how people can better plan their affairs, and if there is a light at the end of the tunnel for the taxpayer.
IHT is a tax that is generally charged on an individual’s death (although despite its name it can also apply to some lifetime gifts and to some trusts).
When someone dies the total value of their assets are totted up. Everyone has a nil-rate band of £325,000 (£650,000 per couple who are married or in a civil partnership) which is taxed at 0% and then the balance is subject to IHT at 40% subject to any applicable deductions, exemptions and reliefs. The nil-rate band of £325,000 came into force from 6 April 2009 and it has now been announced that it will not increase until April 2026 at the earliest despite inflation and substantial increases in house prices. This will mean an incredible 17 years without an increase bringing many more people into the IHT net including many who may not consider themselves to be wealthy.
In addition to the nil-rate band there is the residence nil-rate band which was introduced from 6 April 2017 and is now at £175,000 (£350,000 per couple). This softens the blow for some who have homes that have substantially increased in value. However, despite the Conservative government’s claim that the introduction of the residence nil-rate band fulfilled their promise of enabling couples to give away £1,000,000 (£650,000 + £350,000) free of IHT this is far from the reality for many. The full £1,000,000 is only available where the deceased was married or in a civil partnership, the value of their estate and their spouses’ estate does not exceed £2,000,000, they own a residence worth in excess of £350,000 and they leave it to a direct descendant.
The main exemption is the ‘spouse exemption’ which ensures that no IHT is payable on transfers between husbands and wives or civil partners during their lifetime or on death. However, it is important to note that this exemption does not apply for example to those in long-term relationships or co-habiting who are not married or in a civil partnership.
Certain assets are outside the scope of IHT completely and the most important of these are business property and agricultural property. In many cases it is possible to pass on family businesses completely free from IHT. However, the rules are complex, and it is essential to take proper advice.
For most people by far the easiest way of reducing the IHT bill on death is simply to give assets away. There are no limits on how much you can give away and provided you survive for seven years after making the gift it becomes fully exempt and free of IHT. Even if you do not survive the full seven years after just three years tapering applies to reduce the amount of IHT payable. However, it is important to understand that to get the full IHT relief you cannot give assets away but then continue to benefit from them (for example, you could not give your home to your children but continue to live in it).
It also seems likely that the IHT regime will change at some point. The government set up an All-Party Parliamentary Group in 2019 to look at how IHT might be reformed. Last year the All-Party Group made a number of recommendations which included replacing the current regime with a gift tax payable both on lifetime gifts and on death at a rate of 10% increasing to a rate of 20% for estates over £2m. Making changes along the lines of the All-Party Group’s recommendations would be a major overhaul of the way IHT works in this country. If the recommendations were all put into action all the various reliefs would be abolished except for the spouse exemption and the charity exemption. This would include abolishing business property relief and agricultural property relief. The tax-free rebasing of assets on death for capital gains tax purposes would also be abolished.
The tax rules are complex and any changes will affect people differently depending on their circumstances. It is more important than ever that people seek expert advice now prior to making any significant decisions.
Tim Crook is head of tax at Discreet Law LLP