What is Tax Planning?
Inheritance Tax and Capital Gains Tax do not arise regularly and normally you can decide how and when to allow assets or a transaction to attract some kind of taxation. This decision about timing and the structure of a transaction is tax planning.
Inheritance Tax (IHT) is also known as death duty or estate duty. It is paid from the total amount of money that someone has when they die. There is only one rate of IHT and it is paid at 40% on all assets over £325,000 (the nil rate band for an individual). Therefore, if someone has assets worth £400,000, IHT maybe charged on the surplus over £325,000 (£75,000) resulting in tax of £30,000.
There are slightly different rules for married couples. On the death of the second spouse, the second spouse will be able to use the unused nil rate band of the deceased spouse as well as their own nil rate band, both of which are assessed at the date of death of the second spouse.
It is obvious from the figures above that nowadays many families are facing an IHT liability and the amount paid is likely to be high. Fortunately there are a number of exemptions and reliefs which can be used to reduce and hopefully eliminate this liability. The main aim in IHT planning is to reduce the size of someone's estate so that on death the amount chargeable to tax is small. The easiest way to do this is to give money away.
Main Residence Nil Rate Band
A residence nil rate band has been introduced from 6 April 2017. This is available when residential property is left to direct descendants.
Many people have discretionary will trusts. These should be reviewed urgently as these type of Wills may prevent from being able to claim their inheritance nil rate band if a trust is not a direct descendant.
Everyone has an annual allowance for inheritance tax which means they can give up to £3,000 away and this will be ignored for calculating tax liability on a subsequent death. Parents can give £5,000 to children when they get married. Other relatives can give £2,500. There is a general small gift exemption and the revenue will ignore gifts that do not exceed £250.
Any amount given away in excess of £3,000 in any one year is a potentially exempt transfer (PET). This means that it may be chargeable to inheritance tax if the person dies within seven years of giving the gift.
For example if you give your child £30,000 and then die 5 years later, for tax purposes you will still be treated as owning that £30,000 and inheritance tax may be payable on that sum. If you survive for seven years then you will have successfully excluded the assets from your estate and they will not be taxed.
Gifts from surplus income over expenditure
Regular and habitual gifts out of surplus income are IHT tax free. When an individual receives more net income than they need to live on, they may make arrangements to make regular gifts of any surplus at any level with immediate IHT effectiveness. Provided there is a clear intention to make regular gifts in this manner, even if only one payment happens to be made prior to an unexpected death, the payment will qualify. This exemption is often under utilised in IHT planning but can be extremely useful.
The key elements of this exemption are as follows:
- The gift must be made as part of “normal expenditure”
- It must be paid out of annual income (ie not capital)
- After taking account of the surplus income gifts, the Donor must be left with enough income to maintain the “usual” standard of living
If these factors can be met then the individual can give away surplus income, without any upper limit.
For most people giving away assets to reduce their estate is not practical since it would not leave them with sufficient to live on. There are a variety of products available from financial advisors which can help to protect against the future liability to inheritance tax all of which involve changing how you own assets or increasing your income expenses. An independent advisor would be able to give you further advice. By making a will it is possible to plan how the tax burden will be dealt with and also to ensure that the maximum in exemptions and reliefs is claimed.
At Amanda Greenough Solicitors we can propose a variety of tailor made solutions to most family circumstances either by use of drafting Trusts or Wills.
Life Time Planning
Where people are sure that they have assets that exceed what they believe to be their current and future needs it is possible to remove these from their estates by declaring that they are held on trust for others. This is often done where an outright gift to the persons in question is not appropriate i.e. because they are children or because a wide group of people is intended to benefit but not necessarily at the same time or for the same amount of time.
Generally such trusts will not attract tax if they consist of assets lower than the personal allowance. Amanda Greenough Solicitors can assist with drafting and administering trusts and can advise you on all aspects of trust law.
It is possible to alter the distribution of someone's estate after they have died to incorporate tax planning ideas where they have not previously been considered or where circumstances have changed. For example children may decide that their own needs are well catered for and they do not wish to inherit from their parents but wish to pass the benefit on to their own children. Broadly such post death variations are successful for IHT but may have other consequences for capital gains tax. We will be able to advise you about all the financial implications of a variation and deal with reclaiming tax or registering with HMRC.