Chapter 21: Inheritance Tax Flashcards
1
Q
Why do few estates actually have to pay IHT?
A
Because most estates fall within the IHT nil rate band (£0 - £325,000) and there are a number of tax reliefs that are available.
2
Q
What rate are estates taxed at?
A
40%
3
Q
What lifetime transfers are always chargeable to IHT when made?
A
Lifetime transfers to trusts and companies are always chargeable to IHT when made - and may suffer additional tax if the transferor dies within 7 years of the transfer.
4
Q
When are lifetime transfers to individuals chargeable?
A
Not immediately - but will become so if they exceed the nil rate band and are made within 7 years of the donor’s death
5
Q
How does a person’s domicile affect how IHT is applied?
A
Individuals who are domiciled in the UK are liable to IHT on transfers of all worldwide assets, wherever the assets are situated.
Individuals who are domiciled outside the UK are liable to IHT on transfers of their UK assets onlu
6
Q
What happens if a non-domiciled person owns assets which are situated outside the UK?
A
These assets are ‘excluded property’.
Transfers of excluded property are ignored for IHT purposes.
7
Q
How do we measure the size of a gift?
A
By how much it reduces the donor’s estate - the loss to the donor.
- diminution in value rule
8
Q
What is the general principle regarding which transfers are disregarded for IHT purposes?
A
General principle - if an individual makes a transfer without ‘any gratuitous intent;, that transfer is disregarded for IHT puroses.
9
Q
Is expenditure of the maintenance of an individual’s family treated as a gift?
A
No, even though the donor’s estate will be reduced because of the transfer.
E.g., if a parent pays school fees on behalf of their children.
10
Q
What is the ‘loss to donor’ principle?
A
Because IHT is a tax on what the donor has given away, we have to calculate the loss to the donor’s estate rather than the gain to the recipient of the gift.
E.g., the value of stock in a company sometimes depends on the donor’s percentage of ownership.
- The higher the percentage of ownership, the greater the owner’s control over the company + so the more each share is worth in the donor’s hands
11
Q
What is related property? What special rules apply?
A
Similar property owned by a spouse or civil partner.
If an asset has a higher value taking into account property owned by a spouse or partner than it would have on a ‘stand alone’ basis, under the related property rules, the asset is valued at that higher amount
12
Q
What determines whether PETs are exempt from tax?
A
Whether the donor dies within 7 years of making the gift
13
Q
What are exempt transfers/gifts?
A
- Gifts to spouse
- Gifts to UK and European Economic Area charities
- Small gifts
- Gifts on marriage
- Normal expenditure out of income
- Anything within the annual exemption
14
Q
When are gifts to a spouse not exempt transfers?
A
If the donor spouse is UK domiciled and the recipient spouse is not domiciled in the UK.
Only the first £325,000 of the transfer is exempt from IHT.
15
Q
What is classified as a ‘small gift’?
A
Lifetime gifts of up to £250 to any donee in a tax year.
‘All or nothing’ exemption.
No limit to number of donees.
16
Q
What limits apply to gifts on marriage?
A
Parent - up to £5,000
Grandparent - up to £2,5000
Bride to the groom or vice versa (pre-wedding) - £2,500
All others - £1,000
Not all or nothing exemptions
17
Q
What is considered to be ‘normal’ expenditure out of income?
A
Habitual or regular - a gift that happens year after year.
It will be treated as having been made out of the donor’s income if the donor is left with sufficient income to maintain their normal standard of living
18
Q
What could the ‘normal expenditure out of income’ exemption apply to?
A
Life assurance premiums or personal pension premiums paid by an individual in respect of another person, or
Regular gifts of cash as Christmas or birthday presents
19
Q
What is the annual exemption?
A
£3,000
Means any individual can give away up to £3,000 of value each year outside the exemptions listed previously, without giving rise to IHT
20
Q
How is the annual exemption applied?
A
Set against gifts in chronological order in the tax year
21
Q
Can any unused exemption be carried forward?
A
It may be carried forward for 1 tax year.
If the annual exemption is carried forward, the current tax year exemption must be used before that of the previous year
22
Q
What is the value of a gift for IHT purposes if it is a PET?
A
value of the gift less any available exemptions
23
Q
If tax is owed on a CLT, who is it paid by?
A
Either the donor or by the trustees.
Only owed if the gift exceeds the nil rate band (£325,000 after deducting any available annual exemption).
24
Q
What tax rates are applicable to CLTs?
A
Trustees pay the IHT - 20%
Donor pays the tax - 25%
25
Why does the donor pay a higher rate of tax than the trustee?
Because we have to 'gross up' the transfer if the donor pays the tax, as the amount leaving their estate is the transfer to the trust plus the IHT paid to HMRC
26
How is IHT a cumulative tax?
We need to take account of any other CLTs made by the donor in the previous 7 years (the 'cumulation period').
We add the most recent gift to the sum of other CLTs that have been made within the previous 7 years, and tax is owed if the sum of all the gifts over the 7-year period exceeds the NRB.
Note - only CLTs use up NRB here
27
What is the procedure for calculating lifetime tax?
1. Identify the 'value transferred' using the 'loss to donor' principle,
2. Deduct annual exemption(s) to arrive at the CLT,
3. Identify NRB for year of transfer,
4. Deduct other chargeable transfers made within the 7 years before the gift to arrive at the NRB remaining, and
5. Pay the excess lifetime transfer over the NRB at 20% or 25%
28
How do we determine whether any tax is owed on a PET made within 7 years of the donor's death?
Use the NRB and the IHT rates in force at the date of death.
Work out the amount of NRB remaining by deducting any gross chargeable transfers made in the 7 years before the PET (not from death!)
29
What is taper relief?
If there are more than 3 years between the date of PET and donor's date of death, it applies.
Reduces tax payable by a percentage.
30
What are the taper relief percentages and times?
0 - 3 years - nil
3-4 years - 20%
4-5 years - 40%
5-6 years - 60%
6-7 years - 80%
31
When will additional tax be owed on CLTs?
If the donor dies within 7 years of making the gift.
32
How do you calculate death tax on CLTs?
1. Start with the CLT
2. Calculate the amount of NRB remaining to leave a transfer chargeable to IHT
3. Tax is charged on trustees at death rate of 40%
4. Apply taper relief
5. Minus amount paid on lifetime tax.
33
What tax reliefs are available for lifetime transfers?
1. Business Relief
2. Agricultural Relief
34
What is business relief?
Reduces the value of business property given as a lifetime gift to a trust or at death.
Relief is given before any annual exemption + given automatically if the conditions are satisfied.
No requirement to make a formal claim
35
What business property transfers are entitled to 100% relief?
1. A sole-trade business or a partnership interest,
2. Shares in an unlisted trading company (any number)
36
What business property transfers are entitled to 50% relief?
1. Shares in a quoted trading company if the donor has voting control of the company (more than 50% of the ordinary shares), and
2. Land/buildings/plant and machinery owned by an individual and used either by a partnership of which they are a member or a company they control.
37
What is needed for a business to be eligible for business property relief?
Business relief only given if the business carried on by the sole trader, partnership, or company is trading.
A business whose trade it is to make or hold investments or to deal in property isn't eligible.
If shares are gifted in a trading company that holds some assets as investments, then business relief is available but is restricted to the company's trading asset proportion.
38
What is the general rule re ownership for business relief to apply?
Must have owned the property for at least 2 years before the transfer
39
What exceptions are there to the 2 year ownership rule in business property relief?
1. Replacing one business property asset with another within a 3 year period,
2. Inheriting business property assets from one's spouse
40
What does agricultural relief do?
Reduces the value transferred when assets such as farmland and farm buildings are gifted either during lifetime or on death.
It is given before any available annual exemptions.
Normally available at 100%
Automatic + no formal claim required
41
What property is included for agricultural relief?
Agricultural land or buildings used for the purposes of agriculture and situated either in the UK, the Channel Islands, the Isle of Man, or European Economic Area State.
42
What situations is agricultural relief primarily available in?
1. To a farmer who owns the land and buildings and uses these assets in their own business, or
2. To a landowner who is letting out agricultural land or buildings to a farmer
43
What is not a requirement for agricultural relief to apply?
No requirement for the landowner to farm the land themself
44
What activities are specifically excluded from agriculture?
Grazing horses (except in connection with a stud farm)
Land used for:
- Fishing,
- Shooting, and
- Other sporting rights
45
What is the occupation requirement for agricultural relief to apply?
Agricultural property must have been occupied by the transferor for the purposes of agriculture throughout the 2 years prior to the transfer.
Tenanted land - minimum ownership requirement is extended to 7 years
46
What happens if a farmer runs a farming business?
Eligible for both agricultural relief + business relief on the same transfer.
Agricultural relief is given in priority and applies to the agricultural value of the property.
Business relief may then be available on any excess value in respect of assets used int he owner's farming business which aren't agricultural land or buildings, such as plant and machinery and business goodwill.
Not available if the farmland is leased to a tenant
47
How do we calculate IHT on the death estate?
1. Start with the NRB for the year of death.
NRB is reduced by any CLTs and PETs made in the 7 years prior to death.
2. If any NRB is remaining, we deduct it from the death estate to determine the amount of death estate that is chargeable to IHT of 40%
48
What gifts are exempt in the death estate?
1. Gifts to a spouse/civil partner
2. Gifts to UK/EEA charities
49
How do we value quoted shares?
Look at the official list published by the Stock Exchange at the date of death
50
How do we value jointly owned assets?
If owned jointly by spouses/civil partners - must consider the 'related property' rules
51
What deduction in value is usually applied to joint property is owned not by a married couple?
Reduction in value of between 5% and 15% usually is appropriate.
In practice, this discount will be subject to negotiation with HMRC
52
What property is considered to be 'excluded property'?
Outside the estate for IHT purposes.
1. Non-UK assets for non-UK domiciled individuals,
2. 'Reversionary interests' under a life interest trust or interests in a discretionary trust
53
What liabilities can be deducted from assets?
Allowable liabilities include:
i. mortgages,
ii. income tax owed by the deceased, and
iii. reasonable funeral expenses
54
What costs aren't deductible in the IHT calculation?
Probate costs.
55
What incentive encourages charitable giving?
Where 10% or more of the deceased's net estate has been left to a charity, the taxable estate is charged at 36% instead of the normal 40%
56
What can be done if an individual dies leaving some or all of their nil rate band unused?
A claim can be made for the unused proportion to be transferred to their spouse .
The spouse to whom the unused portion is transferred will then have an uplifted NRB to use against IHT liabilities arising on their death.
57
What can the uplifted NRB not be used against?
Uplifted NRB cannot be used against lifetime tax on chargeable lifetime transfers
58
How can a spouse claim their deceased spouse's unused NRB?
On the death of the first spouse, the unused NRB is recorded but no claim is made.
A claim needs to be made by the executors of the second spouse.
The uplifted NRB is thereafter used in the calculation of all IHT liabilities arising from death.
This will include any tax on PETs and CLTs as well as the death estate.
59
How is a spouse's transferred NRB calculated?
The uplifted NRB is, strictly, a percentage increase equivalent to the percentage of the NRB unused by the 1st spouse to die
60
What happens to the transferable NRB if the taxpayer survived more than 1 spouse?
The NRB on death is calculated by taking into account the unused proportion of each deceased spouse.
However, the proportion transferable is limited to an additional 100%.
61
What is the residence nil rate band?
Available if an estate includes a home that was used as the deceased's private residence at some point if the residence or proceeds of the residence are left to lineal descendants or spouses of such descendants.
62
Who are considered 'children' for the residence NBR?
Biological children
Step-children
Adopted children, and
Foster children
63
How do you calculate the amount of residence NBR?
It is the value of the dwelling at the time of death (after deducting liabilities such as a mortgage secured on that property) up to the residential nil rate band limit (currently £175,000).
64
When does tapering apply to the residence NRB?
For estates with a net value over £2 million, the Residence NRB is tapered away at the rate of £1 for every £2 over that limit.
65
What does 'net value' mean?
Assets less liabilities but before deducting reliefs (such as agricultural and business reliefs) and exemptions (spouse/charity).
66
When will the Residence NRB be eliminated?
For estates over £2.35 million
67
What happens if a predeceased spouse had any unused residence NRB?
Can be transferred between spouses on death (the 'brought forward allowance').
68
Why might a predeceased spouse not have used their residence NRB?
1. The first spouse didn't have a qualifying residence, or
2. The first spouse did have a qualifying residence but didn't leave it to direct descendants.
69
When is the brought forward allowance tapered away?
If the transferor spouse's estate exceeded £2 million
70
What happens if the deceased downsized before death?
Estate will also be entitled to the Residence NRB if the deceased downsized to a less valuable home or sold or gave away their home.
Estate can claim a 'downsizing addition' which uplifts the amount of the Residence NRB in the death estate.
71
When do the downsizing rules apply?
Where a residence valued in excess of the Residence NRB is sold and replaced with a new residence which is valued at less than the Residence NRB at the date of death.
72
When is quick succession relief given?
When an individual's estate had been increased by a chargeable transfer made to them in the 5 years before death.
Chargeable transfer - gift whose value has been charged to IHT.
No requirement for the gifted property to still be owned by the deceased at the date of death.
73
What is the amount of relief available for quick succession relief?
Determined by a complex formula that depends on the no. of years that have passed between the first and second death.
Decreases by 20% for each year between the donor's death and the recipient's death
74
What happens if the PRs sell quoted shares, units in authorised unit trusts, or shares in open-ended investment companies at a loss?
If sold at a loss within 12 months of the date of death, relief is available.
PRs take account of all quoted shares, units in authorised unit trusts, or shares in open-ended investment companies, and the profits and losses are aggregated.
As IHT would have already been paid based on the value of assets at the date of death, a post-mortem claim will usually generate a repayment of IHT
75
What post-mortem claims can be brought in respect of sales of land and buildings?
Relief is available for any sales of land and buildings within 3 years of the date of death.
To calculate the overall loss, we aggregate together all profits and losses in the 3-year period, and any resulting loss is deducted from the value of the estate for IHT purposes.
76
What happens if the executors sell land and buildings at a loss in their 4th year?
These losses can also be counted when working out the overall allowable loss.
Any sales at a profit in the 4th year can be ignored
77
When may woodlands relief be available?
If the deceased's estate included land in the UK which was not eligible for agricultural or business relief but on which trees and underwood are growing.
78
What are the requirements for woodlands relief to apply?
Deceased must have been beneficially entitled to the land for 5 years prior to death (or had inherited the land on the death of another).
79
How does woodlands relief operate?
By excluding the value of the woodlands from the estate.
Any liability to IHT is deferred until the woodlands are disposed of.
Note - relief doesn't apply to the value of the land on which the trees are growing
80
What are the gifts with reservation of benefit rules?
Anti-avoidance measure to prevent a donor from giving away an asset but continuing to derive some benefit from that asset after the gift had taken place.
81
When do the gifts with reservation of benefit rules not apply?
If the donor pays market rent for continued occupation of a property given away.
Neither do the rules apply to situations in which HMRC has issued guidance on where it considers that an insignificant benefit would remain.
82
How can the donor avoid the gift with reservation of benefit rule?
By releasing the reservation before they die.
An asset is treated as forming part of the donor's death estate only if the donor has retained a benefit at the date of death.
If the donor releases their benefit, there is no charge on the death estate.
83
How does HMRC target 'death bed' releases of benefits on gifts with reservation of benefit?
HMRC treats the release of a reservation as being a potentially exempt transfer at the date of release.
The PET is the value of the asset at the date the donor releases his benefit
84
When might the Pre-Owned Asset Tax legislation apply?
For example, if someone sells a house, makes a cash gift of the proceeds, and these are used by the donee to purchase a property that the donor lives in rent-free
85
What do the Pre-Owned Asset Tax rules do?
Impose an income tax charge on benefits received by the former owner of the property if:
1. The former owner benefits directly or indirectly from an asset they previously owned, and
2. The transfer is not within the gifts with reservation of benefit rules
86
When is the IHT due date for CLTs?
IHT due on a chargeable lifetime transfer is payable by the later of 6 months from the end of the month in which the CLT was made, and
30 April after the tax year in which it was made
87
Who is liable and who bears the burden of IHT due on a CLT?
Primarily liability for IHT due on a CLT falls on the transferor (the donor).
Sometimes the transferor will want the trustees to pay the tax and will use the trust fund to do so.
If the transferor is liable but fails to pay, HMRC can pursue the recipients of the transfer (or even the beneficiaries in extreme cases).
88
When is additional tax on death arising from a CLT due? Liability + burden?
Always due 6 months after the end of the month in which death occurred.
Liability falls on trustees.
Burden falls on the trust fund.
In extreme cases, the PRs may become liable, if the tax remains unpaid 12 months after the end of the month of death
89
When is death tax on a PET that becomes chargeable due?
6 months from the end of the month of death of the transferor.
90
Who is liable and bears the burden for the death tax of a PET?
Recipient is liable + suffers the burden of the tax.
If the tax remains unpaid 12 months after the end of the month of death, the PRs become liable
91
When is IHT on the death estate due?
IHT on death is due 6 months after the end of the month in which the death occurs
92
What does liability and burden of IHT on the death estate depend on?
1. Whether it is a freehold estate
2. Whether the property is held in trust,
3. Whether there are gifts with reservation of benefit
4. Whether the property passes outside the will/rules of intestacy
93
Death estate: who is liable and bears the burden for IHT due on a freehold estate?
The PRs are liable for the IHT on a freehold estate.
If the will is silent as to burden, it falls on the residue.
Foreign property suffers the IHT on it.
94
Death estate: who is liable and bears the burden of IHT on property held in trust?
If the property is held in trust, the trustees are liable, and the burden falls on the trust assets (depleting them for the remaining beneficiaries)
95
Death estate: who is liable and bears the burden on property that was a gift with reservation of benefit?
If the property involved was given as a gift, but a benefit was reserved, the donee of the gift is primarily liable to pay the IHT attributable to the property.
If unpaid 12 months after the end of the month of death, the PRs become liable.
96
Death estate: Who is liable and bears the burden of IHT on property that passes other than by will or intestacy?
If the property passes other than by will or intestacy (e.g., the property is an interest passing from 1 joint tenant to another), liability will fall on the PRs but will be borne by the beneficiary.
97
What happens if an individual/PR makes a claim with HMRC to pay IHT by instalments?
The tax is payable in 10 equal annual amounts.
The first payment is due on the normal due date (6 months from the end of the month of death, or the normal due date for lifetime tax, whichever is appropriate).
98
How can individuals and marriage couples mitigate future IHT liabilities?
1. Making lifetime gifts
2. Use of annual exemptions
3. Use of transferable NRB
4. Invest in business or agricultural property
5. Ensure wills are tax efficient
99
Why are lifetime gifts good for tax planing?
PETs - only taxable if the donor doesn't survive 7 years.
- Taper relief can still reduce tax liability
100
Why should appreciating assets be considered for lifetime gifts?
Even if the gift is/becomes chargeable, it is the value at the date of the transfer + not on death that counts for IHT purposes
