Probate and Administration - Inheritance Tax Calculation (6) Flashcards
What is an overview of the inheritance tax calculation?
Inheritance Tax Calculation: IHT is a tax levied on the taxable assets of a deceased person, as well as certain assets given away in the 7 years preceding death (Inheritance Tax Act 1984). There are 5 steps:
(1) Chargeable Transfer: Identify a chargeable transfer. This is a gift which reduces the value of the transferor’s estate in the 7 years prior to death, or forms part of the value of the estate on death.
(2) Value of Transfer: Identify the value of that transfer. This is either the value when owned on death, or the value when gifted in life.
(3) Exemptions and Reliefs: Apply exemptions and reliefs. Various options exist for lifetime transfers and death estate.
(4) Nil Rate Bands: Apply nil rate bands, beginning with lifetime transfers and then death estate. These are effectively personal allowances for IHT.
Nil Rate Band: All parties are subject to a £325,000 NRB.
Residence Nil Rate Band: A further £175,000 may be awarded if a residential home is gifted to issue.
(5) Cumulation and Tax: IHT is levied on the cumulation of all taxable lifetime transfers and death estate that has not benefited from a nil rate band.
Step 1, 2, 3: Identify Chargeable Transfer, Value and Reliefs
Transfer, Value and Relief: It is important to identify all chargeable transfers made by the deceased, calculate their value, and then deduct any applicable exemptions and reliefs. These differ by type of transfer.
How is this process effected for the death estate?
Death Estate: The death estate comprises all assets that the deceased was beneficially entitled to on death, unless excluded.
(1) Assets: Relevant assets include:
Will/Intestacy: Property passing under will or intestacy.
Joint Property: Property owned jointly with another (beneficially) - to the extent of that interest.
Qualifying Interest in Possession: The beneficial entitlement to a fixed income trust conveyed by will (i.e. a life tenant of a will trust).
Reserved Property: Property gifted to another person in life, but in which the deceased retained possession and enjoyment (i.e. transferred house to child but continued to live in it).
(2) Excluded Assets: Interests in future settlements, such as interests in remainder, are excluded. Also, property held in trust for another, such as life policies or death in service benefits in the name of another, are excluded.
Value
Value: The values of the overall estate must be determined (and will be reported to HMRC).
(1) Probate Value: Generally, assets are given a ‘probate value’, which is their market value on death.
Joint Land: Joint tenancy land not held by spouses is discounted by 10% (residential) or 15% (commercial).
Quoted Shares: ¼ difference between highest and lowest prices on the day or closest trading day of death is added to the lowest price to give value.
Related Property: If assets are worth more combined than separate, then it is valued at its proportionate higher value.
(2) Modified Value: Life insurance policies in the name of the testator only derive value after death, so they are valued at their maturity value (s171).
(3) Debts and Expenses: Debts, expenses and funeral costs (not probate costs) of the estate are then deducted from the estate value to give the total death estate value.
Exemptions and Reliefs
Exemptions and Reliefs: Exemptions should be applied before reliefs. Some are specific to death estate assets.
(1) Spousal Exemption: Any asset transferred to a legal spouse (not mere cohabitants) is IHT exempt (s18).
>Non-domiciled spouses capped at exemption of £325,000.
(2) Charitable Exemption: Any asset transferred to charity, national body, political party, and public body (i.e. museum) is IHT exempt (s23).
>If charitable gifts exceed 10% of net estate, then overall IHT is reduced to 36%.
(3) Business Property Relief: Assets of a trading business may benefit from relief. They must have been owned by the deceased or their legal spouse cumulatively for 2 years prior to death.
100% Reduction: 100% reduction for: a) Businesses/Business Interests i.e. partnership shares; b) unquoted shares.
50% Reduction: 50% reduction for: a) listed shares providing 50% voting rights in combination with spouse; or b) land/plant used for their partnership, or a company where they held 50% voting rights.
(4) Agricultural Property Relief: Assets used in agriculture may qualifiy for relief.
Reduction of 100%: a) occupied by transferor for agriculture for two years prior, b) owned by transferor for seven years prior and occupied by someone during that time for agriculture and c) transferor has a right to vacant possession immediately before the transfer or where property is subject to a letting commencing on or after 1 September 1995.
Step 1, 2, 3: Identify Chargeable Transfer, Value and Reliefs
Transfer, Value and Relief: It is important to identify all chargeable transfers made by the deceased, calculate their value, and then deduct any applicable exemptions and reliefs. These differ by type of transfer.
How is this process effected for the potentially exempt transfers estate?
Potentially Exempt Transfers: Potentially exempt transfers are gifts made to individuals, or put into trusts for the disabled, within the 7 years preceding death (s3A).
(1) Gift: This is a gift of an asset which would qualify as chargeable under the death estate (above).
(2) Maintenance Exclusion: Gifts made for the maintenance, education or training of the deceased’s non-adult child, or adult child in full time education, or dependent relative, are excluded (s11).
(3) Potential Exemption: These gifts are called potentially exempt because they will not always be subject to tax.
Value
Value: The value of the PET is the value by which the giftor’s estate decreases on transfer.
(1) Market Value: This is typically determined as the market value of the gift.
(2) Related Property: The value of a transfer of an asset worth more in combination with another of the transferor’s assets is valued at the loss of the total value, not the independent value.
>(A) has two chairs. They are each worth £30,000, but together they are worth £100,000. (A) gives one chair to (B). As such, the loss to their estate is £70,000.
Exception: If the transfer is to a spouse, the loss is calculated as the value of the asset proportionate to the collection.
>(A) gives the chair to his wife. The proportionate value of the chair as part of the collection was £50,000. This is the loss to the estate.
Exemptions and Reliefs
Exemptions and Reliefs: A number of reliefs may apply to PETs. Some are lifetime only.
(1) Spousal and Charitable Exemption: Transfers to legal spouses and charities are exempt from IHT. These should be applied before other exemptions and reliefs.
(2) Business and Agricultural Property Relief: Transfer of qualifying business and agricultural assets may qualify for relief. These should be applied before lifetime only exemptions.
(3) Annual Exemption: The first £3,000 of chargeable transfers made in a tax year are tax exempt. The tax year begins on 6 April.
Rollover: Exemptions may be carried forward by one year only, to a £6,000 maximum exemption. Current exemptions must be exhausted before applying the roll over (preventing infinite rollovers).
(4) Small Gifts: Gifts not exceeding £250 are exempt to any one individual.
>This cannot be used to deduct £250 from a larger gift.
(5) Wedding Gifts: Spousal gifts at a wedding are exempt up to a certain limit, and can be used once per wedding and per spouse. These can be used to deduct value from a larger gift. The exemption differs by the gifting party:
Parents: Up to £5,000.
Remoter Ancestors: Remoter direct ancestors up to £2,500.
Spouses: Spouse to spouse up to £2,500.
Others: All other parties up to £1,000.
(6) Normal Income Expenditure: Gifts forming part of normal income expenditure are exempt, provided the gifting party has sufficient funds to continue their usual standard of living.
>I.e. A parent providing income to their child during their university studies.
Step 1, 2, 3: Identify Chargeable Transfer, Value and Reliefs
Transfer, Value and Relief: It is important to identify all chargeable transfers made by the deceased, calculate their value, and then deduct any applicable exemptions and reliefs. These differ by type of transfer.
How is this process effected for lifetime chargeable transfers?
Lifetime Chargeable Transfers: Lifetime chargeable transfers are gifts to companies and trusts (other than for the disabled).
Value and Exemptions
Value and Exemptions: Value and exemptions are the same as PETs (except small gifts exception).
Immediate Taxation
Immediate Taxation: Once the NRB is exhausted, lifetime chargeable transfers will be partially taxed when they are made.
(1) NRB: The transferor can make up to £325,000 tax free transfers within 7 years. Once they hit this limit, they are taxed as soon as they make an LCT. Any NRB used will refresh after 7 years of a transfer.
(2) Tax: Taxed at 20% immediately (and may be increased to 40% on death, minus the sum already paid).
Step 4: Apply Nil Rate Bands
Apply Nil Rate Bands: Nil rate bands should be applied on death (subject to LCTs).
What is the NRB and TNRB?
Nil Rate Band
Nil Rate Band: The standard nil rate band applies to LCTs and PETs chronologically in the 7 years preceding death, and then to the death estate. Taxing PETs may have the effect of losing NRB that was originally applied to a later LCT during life.
(1) Nil Rate: The nil rate is £325,000.
(2) Spousal Rate: The deceased can inherit the percentage of NRB unused by a spouse who died before 9 October 2007. This percentage increases the deceased’s NRB proportionately, to a maximum 100% increase.
>(A) was married to (B). (A) died in 2008 with full NRB. When (B) dies, they benefit from 100% increase, to a value of £650,000 NRB.
(3) LCTs: LCTs benefit from NRB as soon as they are made. This can have the effect of reducing NRB for a subsequent LCT (and PET on death) made in the next 7 years. This means NRB could have a knock-on effect of 14 years (7 years before LCT/PET which is 7 years before death).
Residence Nil Rate Band
Residence Nil Rate Band: Residence nil rate band is available in addition to the standard nil rate band for deaths since 6 April 2017.
(1) Qualifying Residence: RNRB applies to a dwelling house occupied by the deceased at any time, provided it is gifted to issue, step-children, guardian children, or the same of the legal spouse (unless they remarried).
(2) Nil Rate: The nil rate is £175,000 (or the market value of the property if worth less than £175,000).
>£1 is reduced for every £2 the estate is worth in excess of £2,000,000.
(3) Spousal Rate: Unused spousal RNRB can also be inherited (irrespective of date of death).
(4) Downsizing Allowance: If the deceased sole or downsized their property since 8 July 2015, the PRs can claim the RNRB that would have applied to their higher value property.
Step 5: Apply Tax
Apply Tax: The extent to which transfers are taxed on death will differ.
What are the tax rates?
(1) Rate of Tax: The standard rate of tax is 40%, which is applied after NRB is calculated (NRB is applied to lifetime gifts before death estate). It is 36% if more than 10% of net assets pass to charity (other than on LCTs).
(2) Charged LCTs: Where an LCT was charged in life at 20%, then the IHT owed on it in death is another 20%, to ‘gross it up’.
Tapering Relief on Lifetime Gifts
Tapering Relief on Lifetime Gifts: Once NRB has been accounted for, lifetime gifts may be liable to ‘tapering relief’. IHT is reduced according to how long before death the gift was made.
(1) 3-4 Years: 20% IHT reduction.
(2) 4-5 Years: 40% IHT reduction.
(3) 5-6 Years: 60% IHT reduction.
(4) 6-7 Years: 80% IHT reduction.
