7 IHT Flashcards
(17 cards)
What are the key characteristics of Inheritance Tax (IHT) as outlined in the legislation?
IHT was introduced in 1986, replacing Capital Transfer Tax and becoming the Inheritance Tax Act 1984.
The act is complex because it was not newly written but an amended version of previous law.
It retained old exemptions and added new ones.
The principle of simplicity is undermined, and compliance costs increase as wealthy individuals try to mitigate its effects through planning.
Simplicity and compliance costs are key challenges in the syste
What are the main principles compromised by IHT and the justification for wealth transfer?(3)
- Certainty: Death can occur at any time, making timing unpredictable.
- Convenience: Assets may need to be sold to pay tax when there is no market or the market is depressed.
- The justification for having a wealth transfer on death remains equity and distribution.
Problems with IHT
Equity:
IHT is donor-based and does not consider a beneficiary’s circumstances, leading to inequity.
Estates of the same size may be taxed differently based on:
Frequency of transfer: Tax system favors the healthy and long-lived.
Ease of asset valuation: Difficult-to-value assets, like rare art, create inequity, as the tax system doesn’t maintain horizontal equity.
Redistribution:
Inherited wealth is a significant cause of wealth inequality.
How to improve the Resdistribution Issue in IHT?
Donor-based tax: IHT only achieves redistribution if sufficient wealth is transferred to the public sector. It would be more effective if the tax considered the beneficiary’s circumstances.
Lifetime gifts: Wealthy individuals can avoid IHT by gifting assets during their lifetime. If these gifts were taxed, it would achieve a greater degree of redistribution.
Exemptions and reliefs: The current system has numerous exemptions and reliefs, creating inequalities because different individuals are entitled to different forms of wealth relief.
What are the types of lifetime gifts and their tax implications?
Potentially Exempt Transfer (PET):
Gifts made from one individual to another.
Only taxed if the donor dies within 7 years of the gift.
Chargeable Lifetime Transfer (CLT):
Gifts made to a trust.
Taxable immediately, with additional tax if the donor dies within 7 years of the gift.
Exempt:
Some gifts may be exempt from tax, depending on the nature of the transfer.
Gifts may be exempt from IHT if:
Given to charities.
Given to Community Amateur Sports Clubs (CASC).
For national purposes (e.g., a museum).
Given to qualifying political parties.
Certain monetary exemptions may reduce or exempt the gift from IHT.
Transfers between spouses or civil partners are exempt, both during lifetime and on death.
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Exemptions and Reliefs on Lifetime gifts only
Annual Exemption: £3,000 per year. If unused in one year, it can be carried forward for one year only.
Small Gifts Exemption: £250 per person per year.
Marriage Exemption: £5,000 per parent, £2,500 per grandparent (or party to marriage), £1,000 for any other person.
Normal Expenditure Out of Income: Payments like school fees for grandchildren are exempt, provided they don’t affect the donor’s standard of living and are habitual.
Lifetime gifts AND transfers on death Exemptions/Reliefs
Lifetime Gifts to Spouse/Civil Partner: Exempt from IHT when transferred during lifetime.
Transfers on Death to Spouse/Civil Partner: Exempt from IHT if assets are left to them.
Calculation of tax on lifetime transfers (rates) on death and CLT
The rate of tax payable on lifetime transfers depends on whether the charge arises:
On death: 40% tax rate.
Chargeable Lifetime Transfer (CLT): It depends on who pays:
If the donor pays, it is 25% of the net gift.
If the trustees (donee) pay, it is 20% of the gross gift.
Note: Calculations for CLT are not included in this module
What is IHT charged on?
- The value of assets in the estate at the time of death
- plus, any lifetime gifts (PETs and CLTs) made in the 7 years prior to death (assuming the gifts were not exempt) – this is achieved by considering the effect on the NRB.
- For our purposes – assume the NRB is the same in all years
The process for IHT on the estate at the date of death involves:
- Checking for any CLTs (Chargeable Lifetime Transfers) or PETs (Potentially Exempt Transfers) that may have fallen under IHT due to the donor’s death within 7 years of making the gifts.
- Gifts are taken in chronological order, with no distinction between CLTs and PETs.
- Deduct the value of the NRB (nil rate band) from CLTs and PETs on death.
- Calculate any IHT on the estate (or remaining NRB).
Add up all assets held at the date of death (using the probate value, i.e., the open market value at the date of death).
If any NRB remains, it should be deducted from the estate.
Nil Rate Bands (NRB):
If there is any spare NRB after chargeable PETs and other transfers on death, it can be used to reduce the estate on death (currently up to £325,000).
NRB can be applied against lifetime gifts and the death estate tax.
Additional Residential Nil Rate Band (RNRB) was introduced for 2017/18 onwards, applicable to the death estate (not lifetime gifts).
Any unused NRB or RNRB of a spouse can be transferred to the surviving spouse.
Death estate-assuming PETs and CLT are dealt with
Residence Nil Rate Band
The Residence Nil Rate Band (RNRB) applies to leaving one’s main residence to direct descendants on death (not lifetime).
The initial amount for RNRB in 2017/18 was £100,000, rising by £25,000 each year until a maximum of £175,000 (reached in 2020/21). The current maximum is £175,000.
Added to the standard £325,000, the total combined NRB is now £500,000.
Unused spouse NRBs can be transferred between spouses, potentially making a combined NRB of £1 million.
The extra NRB is withdrawn for properties valued over £2 million.
The amount of RNRB that can be offset is the lower of:
£175,000 (or £175,000 plus the unused portion from a spouse) or
The value of the property after deduction of any repayment/interest-only mortgage.
When is IHT to be paid?
IHT Planning
IHT planning involves using available exemptions, such as lifetime gifts, which may reduce the donor’s estate value, with potential tax benefits if the donor survives for 7 years (taper relief applies after 3 years). Gifts freeze the value at the time given, though CGT may apply, and the residence nil rate band (RNRB) should be considered. To avoid double IHT charges, skipping a generation (passing assets directly to grandchildren) can be effective. Additionally, the unused nil rate bands of a deceased spouse can be transferred, but the RNRB can only be used for direct descendants. Claims for nil rate bands must be made within 2 years of the second spouse’s death.
Summary of IHT
IHT (Inheritance Tax) arises on the transfer of value of chargeable property by a chargeable person.
On Death: The estate may be subject to IHT.
Gifts within 7 years prior to death: These may also trigger IHT.
Other lifetime transfers (e.g., CLTs) may apply, but we do not study them directly. However, it’s important to be aware of them.
