Chapter 7: Wills and Tax Planning Flashcards
IHT nil rate bands
All individuals have a nil rate band (‘NRB’) for IHT purposes. The basic nil rate band is £325,000.
This means that the first £325,000 of a transfer subject to IHT is taxed at 0%.
An individual’s surviving spouse or civil partner can inherit the unused portion of their basic NRB. This is known as the ‘transferable nil rate band’ (‘TNRB’).
IHT nil rate bands
There is an additional nil rate band (currently £175,000) for individuals who leave their family home to direct descendants. This is known as the ‘residence nil rate band’ (‘RNRB’). The RNRB can also be transferred to an individual’s surviving spouse or civil partner.
In this element we cover the NRB, TNRB and RNRB in more detail. We also look at the concept of cumulation.
NRB & Cumulation
Cumulation is used to prevent individuals reducing or avoiding an IHT liability by making a series of separate dispositions. Instead of viewing each chargeable transfer (i.e. failed PET, LCT, death) in isolation, HMRC consider other chargeable transfers made in the 7 years prior to the transfer being taxed. The combined value of these transfer is called the cumulative total.
Cumulative Total
Cumulative total = total chargeable value of all the chargeable transfers made in the previous 7 years.
The effect of the cumulative total is to reduce the NRB available for the transfer under consideration. It is therefore necessary to calculate the ‘cumulative total’ on the relevant date to determine the NRB amount for a particular transfer.
Available NRB = Full NRB less cumulative total
Example: Cumulation
A man died last month having made two lifetime gifts within the last seven years.
· Last year he gifted cash with a chargeable value of £50,000 (a PET).
· Two years ago he gifted shares with a chargeable value of £100,000 (a PET).
As these PETs were made in the 7 years prior to the man’s death they have failed and are chargeable transfers.
His cumulative total on death is £150,000.
His NRB is reduced accordingly (£325,000 - £150,000).
The NRB available on death is £175,000.
Please note that this is a simplified example which doesn’t consider the availability of exemptions or reliefs.
Transfer of basic nil rate band (‘TNRB’)
Before 9 October 2007 the basic NRB would be wasted when a deceased passed their estate entirely to their surviving spouse (because spouse exemption applied to so there was no use for the NRB).
Individuals would often try to make the most of both NRBs by leaving a portion of their estate to other family members or setting up trusts known as ‘nil rate band trusts’. These are discretionary trusts which cover the amount of the NRB and include the surviving spouse as a potential beneficiary. This allows them to benefit without the trust property forming part of their estate for IHT purposes.
Transfer of basic nil rate band (‘TNRB’)
Where one spouse held the bulk of the couple’s assets, they would often be advised to try and equalize their estates, to ensure both had enough assets to make the most of their own NRB.
Such tax planning tends only to be useful for wealthier individuals. In any case, it has become less common since the introduction of the TNRB in the Finance Act 2008.
The TNRB allows a surviving spouse to take advantage of the unused portion of the deceased’s basic NRB.
How the TNRB Works
If a married individual dies and some or all of their NRB remains unused, the PRs of the surviving spouse can claim an increase in the survivor’s NRB equal to the unused percentage of the first spouse’s NRB - the TNRB.
The amount of the TNRB is equal to a % of the NRB sum on the date the survivor dies. It is not simply the unused amount carried forwards. This operates in favour of the taxpayer because the estate of the surviving spouse will benefit from any increase in the NRB threshold which occurs after the first death. For example, if the NRB was £312,000 when the first spouse died but had increased to £325,000 by the time the second spouse died, the amount of the TNRB would be calculated with reference to £325,000 not the lower figure of £312,000. Therefore, if the first spouse to die had used 50% of their NRB, when the second spouse died the transferable amount is £162,500.
NB: if the NRB amount has not changed between the date of the first and second death, the unused amount and unused % will be the same.
Outliving multiple spouses
The TNRB is only available after the surviving spouse dies. Therefore, it cannot be claimed in respect of a chargeable lifetime transfer when it is made by the survivor.
The date of the first spouse’s death doesn’t matter i.e. it can pre-date the introduction of the TNRB. The TNRB can apply provided the survivor’s death occurred after the introduction of the TNRB.
Outliving surviving spouses
Individuals who have survived more than one spouse can claim the TNRB in respect of all of them, subject to a cap of 100% of a full nil rate band being transferred.
Individuals who would be entitled to claim a TNRB with regards a previous marriage/civil partnership can also pass this on to any subsequent spouse they have (again capped at 100% of a full NRB).
On the next page, we consider examples involving multiple marriages in more detail.
Example: Outliving multiple spouses
· A and B were married. B later died. Following B’s death, 20% of his NRB was used (leaving 80% unused).
· A then married C. C later died. Following C’s death, 50% of his NRB was used (leaving 50% unused).
· A has just died.
A’s PRs can claim a TNRB from both B and C (80% from B and 50% from C). However, the total is capped at 100% (one full NRB of £325,000).
A’s PRs can claim A’s own NRB plus 100% TNRB (from B/C), thus increasing A’s NRB from £325,000 to £650,000.
· D and E were married. E later died. Following E’s death, 90% of her NRB was used (leaving 10% unused).
Examples: Outliving multiple spouses
· D then married F. F died later. Following F’s death, 70% of her NRB was used (leaving 30% unused).
· D has just died.
D’s PRs can claim a TNRB from both E and F (10% from E and 30% from F).
D’s PRs can claim D’s own NRB plus 40% TNRB (from E and F), thus increasing A’s NRB from £325,000 to £455,000 (£325,000 + £130,000 (40% of £325k)).
Example: Passing TRNB to a new spouse
· A died 15 years ago, survived by wife, B. A left all assets to B, meaning A’s NRB was unused.
· B married C five years ago.
· B died two years ago, leaving her entire estate to the children from her first marriage. 50% of her NRB remained unused. B’s PRs didn’t need to claim TNRB from A because B didn’t use her whole NRB.
· C died recently, leaving his estate (worth £700,000) to his siblings. He has a full NRB available.
Example: Passing TRNB to a new spouse
C’s NRB doesn’t cover the full value of his estate. His PRs will therefore want to claim the TNRB from B’s estate.
B’s total available NRB included B’s own NRB (of which 50% remained unused) and A’s full NRB, to which B’s estate was entitled but did not claim (worth £325,000).
The claim by C’s PRs for a TNRB will be capped at one full NRB. C’s PRs can increase C’s NRB to £650,000, but no more, even though B’s total ‘available but unused’ NRB would be worth more than £325,000.
TNRB Making a Claim
No claim needs to be made when the first spouse dies.
The PRs of the surviving spouse must make a claim for the TNRB in the IHT return within two years of the end of the month of death (or within three months of the PRs first acting, if this is later). If they fail to do so, anyone else who is liable to pay the IHT on the surviving spouse’s death can make the claim after the deadline for the PRs to claim has passed.
HMRC has discretion to extend the deadline.
TNRB: Making a Claim
If an individual survives more than one spouse, a separate claim must be made for each TNRB. It is advisable to do this even though the cap means that only one TNRB might actually be needed (in case there is an error discovered in the IHT returns of any of the deceased spouses).
The PRs of a surviving spouse can also make a claim for any TNRB the deceased spouse was entitled to on the death of a previous spouse (if their own PRs had not made such a claim already).
Residence NIL Rate Band
The RNRB was introduced by the Finance (No 2) Act 2015. It provides an additional nil rate band where the following conditions are satisfied:
· The deceased died on or after 6 April 2017
· Their death estate included a ‘qualifying residential interest’ (‘QRI’)
· The QRI was ‘closely inherited’ by a ‘direct descendent’
If part of the QRI is closely inherited but the other part is not, only the chargeable value of the share which is closely inherited is taken into account when calculating the value of the RNRB.
RNRB Amount
The amount of a full RNRB is £175,000.
If the deceased’s share or interest in the property (after the deduction of any mortgage on the property) is worth less than £175,000, the RNRB amount is capped at the value of the property.
Where the RNRB is claimed it is applied to the death estate as a whole rather than set-off against the gift of the property separately
RNRB Amount
There is a tapered withdrawal of the RNRB for estates with a net value (here this means the value of the assets which comprise the taxable estate, after debts have been deducted, but before exemptions and reliefs are applied) of more than £2 million.
The reduction in the RNRB is £1 for every £2 above the £2 million threshold.
There is no RNRB available at all for net estates worth £2,350,000 or more (or £2,700,000 where a full transferred RNRB applies).
RNRB: Qualifying residential interest (QRI)
A QRI is a residential property interest which is part of the deceased’s estate immediately before death.
Where the deceased had more than one residential property interest in their estate at death, the PRs must nominate one of them as their QRI.
A residential property interest is an interest in a dwelling-house which the deceased occupied as their residence at some point during their period of ownership.
RNRB: Qualifying residential interest (QRI)
It includes property in which the deceased did not live (because they were living in other job-related accommodation) but intended to do so in in due course. It does not include rental investment properties in which the deceased never lived.
A dwelling-house can include the garden/grounds (if the land is not subject to a woodlands relief election).
RNRB: Meaning of ‘closely inherited’
A QRI must be ‘closely inherited’.
A beneficiary closely inherits from the deceased if they receive the QRI by:
· gift under the will - either as a specific legacy of the deceased’s home, or by taking a whole or part share of the residue which includes such property
· operation of the law of intestacy
· operation of the rules of survivorship
Circumstances in which they closely inherit from the deceased
There are other circumstances in which a person will ‘closely inherit’ from a deceased e.g. where there are gifts into certain types of trust, or where the deceased has received a GROB, but these rules are beyond the scope of the module.
Unless a specific exception applies, a beneficiary with a contingent interest following death does not ‘closely inherit’ for these purposes as they are not receiving an absolute interest e.g. it would not apply to a gift to a grandchild who was aged 15 if the gift was contingent on their reaching 25.
Meaning of direct descendents
A QRI must be ‘closely inherited’ by one or more direct descendants. The following are included as direct descendants of a deceased person (s 8K IHTA 1984)
1) The deceased’s children, grandchildren, great-grandchildren and other lineal descendants,
2) Spouse or civil partner of anyone included in 1) above,
3) Widow, widower or surviving civil partner of anyone included in 1) above who has pre-deceased the deceased, provided the survivor does not re-marry or enter a new civil partnership before the deceased dies
Considering 1) above
When considering 1) above: adopted children, step-children (if their parent was married to the deceased), foster children and children for whom the deceased was a guardian or special guardian are included.
The deceased’s siblings, parents, nieces, nephews are not direct descendants.
Example: RNRB
A man died this year, leaving his entire estate (worth £500,000) to his children. He has a full basic NRB available. The estate includes the family home (worth £250,000).
Without the RNRB, the estate would not all be covered by the NRB.
The family home is a QRI and the man’s children are direct descendants. The conditions for using the RNRB are therefore met. As the family home is worth more than the RNRB, the full amount of the RNRB is available.
The man therefore can use both his NRB of £325,000 and RNRB of £175,000. Together they cover the value of the man’s estate. There is therefore no IHT to pay on the man’s estate.
Transferring unused Residence NRB
It is also possible to transfer any unused RNRB to a surviving spouse.
The transfer of the RNRB is relevant when the survivor of a married couple dies and their pre-deceased spouse did not use their own RNRB. This may arise where the first of the couple to die:
· did not own a QRI e.g. they did not own a residential property; or
· they did not qualify for the RNRB because they left a QRI to someone who was not a lineal descendant e.g. they left their entire estate to the surviving spouse.
Transferring unused Residence NRB
Note that providing the survivor dies after April 2017 they will be able to claim a transferred RNRB even if their pre-deceasing spouse died before this date.
A transferred RNRB can only be used if the surviving spouse leaves a QRI to a direct descendant (i.e. conditions for the RNRB must be met on the second death).
Transferring unused RNRB
The home that the surviving spouse leaves to their direct descendants does not have to be the same house that they lived in with their deceased spouse(s) (the deceased spouse does not need to have owned any QRI).
Transferring the RNRB works in the same way as transferring the basic NRB, allowing the surviving spouse to increase the value of their RNRB by up to 100% (based on the percentage remaining of the deceased spouse’s RNRB). Where a full transfer occurs, an estate may qualify for a RNRB of £350,000 (£175,000 + £175,000).
Tapered withdrawal
The tapered withdrawal of the RNRB for net estates worth more than £2 million applies with reference to the total RNRB. Where the survivor’s estate could claim £350,000 RNRB this amount is reduced by £1 for every £2 in excess of £2m, and no RNRB can be claimed for net estates worth £2,700,000 or more.
Example: Transferring RNRB
A died five years ago, leaving her entire estate to civil partner, B.
B died this year, leaving her estate to daughter, C. The estate includes the family home (worth £350,000).
B’s PRs can make a claim for the unused RNRB from A’s estate.
The total RNRB available for B’s death estate is £350,000 (B’s own RNRB of £175,000 plus an additional 100% uplift in respect of A’s RNRB).
Where the RNRB is claimed it is applied to the death estate as a whole, rather than set-off against the gift of the QRI separately.
RNRB: Downsizing
Broadly, to qualify:
the deceased must have given away their QRI or downsized to a less valuable QRI on or after July 2015 (i.e. have lost the benefit of the full RNRB)
the former home would have been a QRI if it had been retained
a direct descendant inherits the replacement QRI and/or other assets
The amount of the addition is calculated with reference to the amount of the RNRB which would otherwise be lost because the former QRI is no longer owned (or a less valuable QRI has taken its place).
Claim for downsizing addition
A claim for the downsizing addition is made by the PRs within 2 years of the end of the month of death, not when the sale/gift of the former home takes place. However, details of the lifetime sale/gift will be needed by the PRs to bring the claim.
The downsizing addition is only relevant if there is no QRI in the estate when the deceased died (but there was historically), or the value of the new QRI following a downsizing move is less than the current maximum RNRB.
The downsizing rules are not relevant if:
· there is no loss of the RNRB because the value of any new QRI in the estate is the same/more than the maximum available RNRB, or,
· the RNRB is not available, because the new QRI or assets are not left to a direct descendant
Application of the rules is complex and beyond the scope of this module but will never produce a total RNRB greater than the maximum otherwise normally available.
Maximum combined NRB
It is possible for a person’s estate to qualify for a total NRB amount of £1million.
Consider the following:
· A and B are married. A dies leaving all of their estate to B. A made no lifetime gifts.
· On A’s death no NRB is used because the whole of A’s estate passes to their spouse and is spouse exempt.
· B then dies leaving the whole of their estate to their children. B made no lifetime gifts.
· B’s estate is worth £1million and includes a family home worth £500,000
When B dies, B can claim
When B dies, B’s PRs can claim:
· B basic NRB of £325,000
· B’s RNRB of £175,000 (the house passes to a direct descendent)
· A’s unused basic NRB of £325,000 (TNRB)
· A’s unused RNRB of £175,000 (transferred RNRB)
This gives a total combined NRB of £1 million (£325,000 + £325,000 + £175,000 + £175,000).
No IHT is payable on B’s death.
Summary
· Each individual is entitled to a basic nil rate band of £325,000 (‘NRB’). Chargeable transfers up to the value of the NRB are taxed at 0%.
· The NRB available is reduced by a person’s cumulative total. The cumulative total = total value of the chargeable transfers made in the previous 7 years.
· The PRs of a surviving spouse/civil partner can claim the unused % of the NRB of the pre-deceased spouse/civil partner (the transferred NRB (‘TNRB’)). The TNRB is capped at 100% of the basic NRB at the date of the survivor’s death.
Summary
· On death, an additional nil rate band of £175,000 can be claimed if the deceased left a ‘QRI’ to a direct descendant, referred to as the ‘residence nil rate band’ (‘RNRB’). There is a tapered reduction in the RNRB for estates worth more than £2 million.
· The PRs of a surviving spouse/civil partner can claim the unused % of the RNRB of the former spouse/civil partner (the transferred RNRB). The transferred RNRB is capped at 100% of the amount of the RNRB at the date of the survivor’s death.
· Estates without a QRI (or a QRI worth less than the maximum RNRB) might benefit from the downsizing rules.
Maximum Combined Value of the NIL Rate Bands
Correct: A surviving spouse can make use of their own basic NRB (£325,000) and RNRB (£175,000) and receive a transfer of up to 100% of the basic NRB and RNRB from the estate of their deceased spouse.
IHT calculation on lifetime transfers
In this element we look at the full process of calculating the inheritance tax (‘IHT’) due on lifetime transfers.
There are two separate calculations that may be required:
The tax due on an immediately chargeable lifetime transfer (LCTs only).The tax due as a result of the transferor dying within seven years of making a lifetime transfer (LCTs and failed PETs).
You will need a calculator to follow the examples in this element.
Potentially Exempt Transfer
A PET is a lifetime transfer of value to another individual. If the individual doesn’t survive for seven years after making the transfer, it becomes chargeable alongside their death estate. The rationale behind PETs is to prevent individuals avoiding IHT by giving away property shortly before their death.
The tax treatment of a PET is as follows:
- The transfer is not chargeable at the point it is made. No IHT is payable yet.
- It becomes fully exempt if the transferor survives seven years from the date of the PET.
- If the transferor dies within seven years of making the PET, the PET ‘fails’ and becomes a chargeable transfer and thus subject to IHT.
Lifetime Chargeable Transfer
All lifetime transfers of value made by a person into a trust on or after 22 March 2006 will give rise to an LCT.
The tax treatment is as follows:
- An LCT is a chargeable transfer when it is made. IHT is payable on the chargeable value of the LCT at the lifetime rate of 20%.
- If the transferor survives 7 years following the LCT there is no further charge to tax.
- If the transferor dies within 7 years, the LCT will be reassessed to tax at the death rate, using the NRB at the date of death.
Practice Alert
Practice Alert: There are different rules for trusts set up for disabled people provided that statutory requirements are met. These rules are outside the scope of this module.
Steps to calculate IHT on Lifetime Transfers
The following formula should be used when calculating IHT on lifetime transfers:
Step A
Calculate cumulative total
Step B
Identify value transferred
Step C
Apply exemptions and reliefs
Step E
Apply taper relief
Step F
Give credit for tax paid in lifetime
Note that Steps E and F only apply when the IHT is being calculated after death.
Calculation of Cumulative Total
The cumulative total is relevant to lifetime transfers as it tells us how much of the nil rate band (‘NRB’) is available for the transfer. The cumulative total is calculated by adding up the value of all chargeable transfers made in the 7 years prior to the transfer.
Although cumulation only takes into account chargeable transfers made in a 7 year period, where an LCT or PET is reassessed, this can mean looking back as far as 14 years before the transferor’s death.
For example, if an LCT was made 7 years before the transferor’s death, it will be reassessed to tax at the death rate when the testator dies. It is then necessary to calculate the cumulative total for the LCT based on the 7 years prior to the LCT (i.e. the 7 year period starting 14 years before the death).
Cumulation Example
A man makes the following transfers:
- 10 years before death: An LCT (chargeable value £4,000)
- 6 years before death: PET 1 (chargeable value £50,000)
- 2 years before death: PET 2 (chargeable value £10,000)
Both PETs have failed, making them chargeable. The LCT is also a chargeable transfer. It is not reassessed (it was made more than 7 years before death) but is relevant to the cumulative total.
Cumulative Total
- The cumulative total applicable when calculating the IHT due on PET 1 is £4,000 (as the LCT was made 4 years before PET 1).
- The cumulative total applicable when calculating the IHT due on PET 2 is £50,000 (as PET 1 failed, has become chargeable and was made 4 years before PET 2. NB: the LCT is not considered as it was made more than 7 years before PET 2).
- The cumulative total applicable when calculating the IHT due on the death estate is £60,000 (as both PETs have failed)
If a PET fails, it is chargeable
STEP B: Identify value transferred
A ‘transfer of value’ is a ‘disposition’ which results in an immediate decrease in the value of the individual’s estate (s 3(1) IHTA).
Broadly, this means gifts but it can also include transactions at an undervalue (e.g. selling your house to a family member for less than it is worth – the difference in value counts as a gift). It applies to gifts of all forms of property (i.e. anything with a monetary value).
For lifetime transfers, the value of a transfer is assessed by reference to the loss in value to the donor at the date of the transfer.
Exemptions and Reliefs
- Spouse exemption
- Charity exemption
- Family maintenance exemption
- Annual exemption
- Small gifts allowance
- Normal expenditure from income
- Marriage exemption
- Business property relief
- Agricultural property relief
Example Calculation of Applying Exemptions and Reliefs
After applying all relevant exemptions and reliefs you will reach a figure for the chargeable value of the transfer. There are a lot more exemptions and reliefs available for lifetime transfers than for the death estate, so make sure you make use of them in the most efficient way.
A man makes a wedding gift of £12,000 to his daughter. He has made no other gifts in the last two years.
Apply reliefs in the following order:
- Marriage exemption: £5,000
- Current Annual Exemption (‘AE’): £3,000
- Last year’s AE: £3,000
Deduct total value of exemptions from value of gift to reach chargeable value: £12,000 - £11,000 = £1,000
Step D: Apply NRB & Calculate Tax
Once you have established the chargeable value of the transfer, the basic NRB can be applied against the remaining taxable value.
Establish the value of the NRB.
Reduce the total NRB by the value of the cumulative total (from Step A).
Apply a rate of 0% to the value of the remaining taxable estate up to the total NRB amount.
Apply the relevant rate to the rest to establish the IHT due.
Key points to note:
- The residence NRB never applies to lifetime transfers.
- The NRB applicable to an LCT when it is first made is the NRB at the date of the transfer.
- The NRB that applies to a failed PET or re-assessed LCTis the NRB at the date of death.
As the NRB has been fixed at £325,000 since April 2009, this is the figure you should use unless a question tells you otherwise.
Rates of Tax
After deducting the NRB, it is necessary to apply IHT to the remaining amount at the appropriate rate. This rate will differ depending on whether you are dealing with the tax due immediately on an LCT or are re-assessing a lifetime transfer (LCT or PET) because the transferor has died within seven years.
LCTs: When calculating the tax due immediately on an LCT, the tax is payable at the lifetime rate of 20%. Step D is the final step in the calculation.
Failed PETs and re-assessed LCTs: Tax is payable at the death rate of 40%. If the transferor dies 3-7 years after making the transfer, it is also necessary to apply taper relief at the relevant rate to reduce the IHT payable.
LCT Example: Lifetime rate
Step A: Calculate cumulative total
£0 (as the earlier PET has not yet failed)
Step B: Identify value transferred
£400,000
Step C: Apply exemptions and reliefs
AE for year of LCT: £3,000
AE for previous year: £3,000
Chargeable value: £400,000 - £6,000 = £394,000
Step D: Apply basic NRB and calculate tax
Nil rate: £325,000
Lifetime rate: (£394,000 – £325,000) = £69,000
£69,000 @ 20% = £13,800
Steps E and F: Reassessed transfers
PETs or LCTs made in the 7 years before death must be reassessed to IHT. This is separate to the calculation of IHT on the death estate. Although death is the trigger for the lifetime transfer being reassessed, these transfers do not form part of the death estate. The tax payable on a failed PET or reassessed LCT must be calculated separately.
If a PET or LCT is being reassessed it is necessary to consider Step E of the calculation (which involves applying taper relief to transfers made 3-7 years before the death)
If tax was paid on an LCT during the transferor’s lifetime and it is later reassessed at the death rate, it may also be necessary to consider Step F (which involves giving credit for tax paid in the transferor’s lifetime).
Step E: Taper Relief
The rates of taper relief are set out below. You will see these rates expressed either as a % reduction in the amount of IHT due, or confirmation of the % that remains payable. Both produce the same outcome.
Step F: Giving credit for tax paid in lifetime
Where an LCT is being reassessed at the death rate, it is also necessary to factor in any tax that was paid at the lifetime rate.
This is done by deducting the IHT paid previously from that due as a result of the death (after taper relief has been applied). Only the balance needs to be paid to HMRC.
If the balance is reduced to nil as a result of crediting the previous payment, there will be no further tax to pay.
It is not possible to obtain a refund for the lifetime payment if the balance is negative.
LCT Example: Reassessing LCT
Worked Example
Fact Pattern: A man settles £400,000 on trust for his grandchildren (an LCT). Tax of £13,800 was paid on the LCT during the man’s lifetime. He made one PET (chargeable value £50,000) three years before the LCT. He dies three years after the LCT. He has made no other transfers. Calculate the IHT due on the LCT after the man’s death.
Step A: Calculate Cumulative Total
£50,000 (because PET has failed)
Step B: Identify value transferred
£400,000
Step C: Apply exemptions and reliefs
AE (£3,000) x 2 = £6,000
Chargeable value: £400,000 - £6,000 = £394,000
Step D: Apply basic NRB and calculate tax
Nil rate: (£325,000 - £50,000) = £275,000 @ 0%
Death rate: (£394,000 – £275,000) = £119,000
£119,000 @ 40% = £47,600
Step E: Apply Taper Relief
LCT 3 years ago. 80% of £47,600 = £38,080
Step F: Give credit for tax paid in lifetime
£38,080 - £13,800 = £24,280
Total IHT Payable = £24,280
Practice Alert: Grossing Up
If IHT is payable as a result of a lifetime transfer and the transferor pays the tax (in addition to the gift itself), the reduction in the value of his estate includes the amount of IHT paid as well as the gift itself.
The value of the gift must be ‘grossed up’ to find the total value transferred before the tax due is calculated.
Grossing up is outside of the scope of the module but it is something to be aware of if you encounter IHT (or indeed other taxes) in practice.
Summary
· LCTs are lifetime transfers into a trust. PETs are lifetime transfers to an individual.
· LCTs are immediately chargeable to IHT at a rate of 20%. Use the following process to calculate the tax due:
A. Calculate the cumulative total
B. Identify the value transferred
C. Apply exemptions and reliefs
D. Apply basic NRB and calculate tax at the appropriate rate
IHT: Death estate
Steps to Calculate the Death Estate
Step 1
Calculate cumulative total
Step 2
Identify assets included in the taxable estate
Step 3
Value the taxable estate
Step 4
Deduct debts/expenses
Step 5
Apply exemptions & reliefs
Step 6
Apply RNRB
Step 7
Step 1: Calculate the Cumulative Total
The cumulative total is relevant to the death estate as it tells us how much of the nil rate band (‘NRB’) is available. The cumulative total is calculated by adding up the value of all chargeable transfers made in the 7 years prior to the death.
Consider the example below. (Note this is a simplified example which doesn’t take into account the availability of any exemptions or reliefs.)
A man died last week. He made the following chargeable transfers in the last 7 years:
- A PET, three years ago (chargeable value £20,000). This has now failed.
- An LCT, two years ago, (chargeable ,value £5,000).
The man’s cumulative total is £25,000. His NRB is therefore reduced from £325,000 to £300,000.
Step 2: Identify the Taxable Death Estate
It is crucial to appreciate that the rules determining the property included in a person’s estate for tax purposes are different to those which govern the property included in a person’s succession estate. Therefore, the value of a person’s taxable death estate will frequently be different to the value of their succession estate.
The general rule is that all property to which the deceased was beneficially entitled at the date of death is included in the estate for IHT purposes. This would include property situated both in the UK and abroad (where the taxpayer is UK-domiciled).
However, certain items of property may appear to belong to the deceased but are excluded for IHT purposes and conversely other types of property which do not belong to the deceased before death are included in the taxable estate.
Assets included at Step 2
The following assets are included in the taxable estate even though, in some cases, it may not be immediately obvious why (e.g. because the deceased did not actually own the asset when they died):
- All jointly owned property
- Property subject to a reservation
- Donationes mortis causa
- Statutory nominations
- Some interests in possession
Jointly owned property
Where the deceased owned property as a tenant in common, this share passes into the deceased’s estate for both tax purposes and distribution purposes.
Where the deceased owned property as joint tenants with another/others the distribution of the property and the tax position are considered separately.
Although the survivorship rule applies for distribution purposes, for IHT purposes there is a deemed severance of the joint tenancy immediately before death. This means that the deceased’s ‘share’ of the property will be included in their taxable estate.
Example
A testator’s estate consists of:
- House in sole name: £300,000
- Chattels (joint tenants): £8,000
- Cottage (tenants in common in equal shares): £200,000
The succession estate is worth: £300,000 (house) + £100,000 (1/2 cottage) = £400,000. The chattels pass by survivorship.
The taxable estate is worth: £300,000 (house) + £4,000 (half chattels) + £100,000 (1/2 cottage) = £404,000.
Property Subject to Reservation
If a person gives an asset away during their lifetime but reserves a benefit in that asset, the value of the asset at date of death will be included in the donor’s IHT estate when they die at the date of death value (s 102 Finance Act 1986).
The most common example is where a parent transfers legal ownership of a property e.g. a holiday cottage to their children on the condition that the donor can continue to use it whenever they wish and free of charge. The parent in this case has reserved a benefit in an asset they previously owned and on the parent’s death the value of the holiday cottage at that date will be included in their estate for IHT purposes.
Individuals can avoid the gift with reservation of benefit (‘GROB’) rules by ensuring that they either do not derive any benefit from the assets they have given away, or, by paying a market value rent for the time they do derive benefit e.g. paying rent each time the donor uses the holiday cottage.
Donationes mortis causa
A donationes mortis causa (‘DMC’) is a lifetime gift which is made conditional on death. At the date of death the donor no longer owns the asset as it has been given away while they are alive.
However, the conditional nature of the gift (and the donor’s ability to revoke it up until death) means that for IHT purposes the subject matter of the DMC is still part of the deceased’s estate and IHT will be payable on its value as at the date of death.
Statutory Nominations
A person can make a written nomination of monies in any of the following accounts:
- Friendly Society
- Industrial Society
- Provident Society
The amount in each account must not exceed £5,000.
On the death of the deceased, the monies in the relevant account(s) pass to the nominee, do not enter the distribution estate and may be distributed without a grant. However, such monies do form part of the IHT estate.
Interests in possession trusts created before 22 March 2006
Before 22 March 2006, the capital value of all interest in possession trusts was treated as being owned by the person with the interest in possession (i.e. the life tenant) for IHT purposes (s 49(1) IHTA). It was therefore included in the life tenant’s taxable estate.
This is still the case for existing interest in possession trusts provided they were created before 22 March 2006.
Example
A man died last week. At his death, the man’s estate was worth £200,000. He was also the life tenant of a trust created in 2004. The capital value of the trust fund at the man’s death s £150,000.
The taxable value of the man’s estate is £350,000 as it includes the value of the trust fund.
Interests in possession trusts created on or after 22 March 2006
After March 2006, if a life interest trust is created following someone’s death e.g. by will, the life interest is referred to as an ‘immediate post death interest’ (s 49A IHTA). When a life tenant with an immediate post death interest dies, the capital value of the trust is included in their taxable death estate.
If a new inter vivos life interest trust is created i.e. during the lifetime of the settlor, on or after 22 March 2006, the life tenant’s interest is not included in their taxable estate
Interests in possession trusts created on or after 22 March 2006
Where the initial trust was created before that date, the rules on the previous page continue to apply, although there are special rules for ‘transitional serial interests’ (trusts with successive life interests, e.g. to A for life, then to B for life, then to C absolutely) where the successive life interests arise on or after 22 March 2006. You do not need to know about transitional serial interests
Example
A woman died last week owning assets worth £200,000. She was also the life tenant of a trust created following her father’s death in 2012. The capital value of the trust at creation was £30,000, but had increased to £50,000 when the woman died.
The taxable value of the woman’s estate is £250,000 because it includes the value of the trust fund when she died. The life interest trust was created following the death of the woman’s father so she had an immediate post death interest.
Assets excluded in Step 2
- ‘Excluded property’
- Insurance policies written in trust for a third party
- Discretionary pension scheme payments
Excluded Property
The most common example of excluded property is a remainder interest (sometimes called a reversionary interest) in a life interest trust.
If the remainderman of a life interest trust dies before the life tenant, the trust fund that would have passed to them on the life tenant’s death is not included in the remainderman’s taxable estate.
In contrast, where a life tenant dies, the value of the trust fund is included in their taxable estate.
Insurance Policy Written on Trust
If the deceased had an insurance policy on their own life where the sum payable on death was written in trust for another the proceeds of the policy are not included in the deceased’s estate for IHT purposes.
If the policy proceeds were payable to the deceased’s estate then the amount would be included in the taxable estate.
Discretionary Pension Schemes
If the deceased was a member of an employer’s pension scheme any discretionary lump sum payment made by the pension fund trustees is not included in the taxable estate. As the payments are made entirely at the trustees’ discretion the deceased is not deemed to have any entitlement to the money, and the amount paid out (whether to a third party or to the deceased’s PRs) does not form part of the deceased’s estate for IHT purposes.
Discretionary Pension Schemes
Many pension schemes allow contributors to indicate during their lifetime who should receive the money (often in an ‘Expression of Wish’ form) if the trustees exercise their discretion to make a payment after their death. The contributor’s expression of wish is not binding on the trustees as the nature of the payment is discretionary and they are not legally obliged to pay the person(s) indicated by the contributor, although in practice they almost always do.
Pension lump sums payable by rightto the estate of the deceased are included in the taxable estate.
Step 3: Value of the Taxable Estate
The general rule is that the assets in the estate are valued at market value at the date of death. However, some special rules apply in certain circumstances:
Quoted shares: If the deceased owned quoted shares there are special rules for establishing the date of death value linked to the stock exchange prices on that date. They are valued by taking the lower of the two prices on the Stock Exchange Daily List and adding one-quarter of the difference between the higher and the lower value. An example can be found in another element.
Related property: If assets owed by spouses are worth more when valued together (e.g. because they form a set), each party’s share is valued at their proportionate share of the combined pair.
