WAE and BLP - IHT: the charge to IHT

What are the three IHT trigger events?

- Potentially exempt transfers ('PET')

- Lifetime Chargeable Transfers ('LCT')

- death

What is a potentially exempt transfer?

- Lifetime transfers of value

- no IHT is payable when the transfer is made

- will become chargeable if transferor dies within seven years of making the PET

What are lifetime chargeable transfers?

- transfers of value into a trust made on or after 22 March 2006

How is IHT chargeable on LCTs?

- immediately chargeable to IHT at the lifetime rate of 20% - if above the NRB

- if transferror survives for next 7 years, there is no further charge (remains at 20%)

- If T dies within 7 years, the only change is that the bit above the NRB is charged at 40%

- but you have already paid some of this at 20%, so you only need to pay the difference between what you've already paid

What is a transfer of value?

a disposition which results in an immediate decrease in the value of the individual's estate

e.g., gifts, underselling something

What is the basic nil rate band?

- first £325,000 of chargeable transfers will be taxed at 0%

What is the transferable nil rate band?

An individual's surviving spouse or civil partner can inherit the unused proportion of their basic NRB or residence NRB.

How does the transferable nil rate band work?

- PRs of surviving spouse will claim an increase in survivor's NRB equivalent to the unused percentage of first spouse's NRB

What is the residence nil rate band?

- in addition to basic NRB

- an additional £175,000 will be taxed at 0% for those who die after 6 April 2017 if they leave their family home to direct descendants

e.g., T has an estate of £500,000. Will assess taxable portion by removing £175,000 and £325,000 = £0 left, therefore there is no taxable portion left.

How is a person taxed when they die?

- deemed transfer of the assets they own at the time of death

- property is valued at the price it might reasonably be expected to fetch if sold on the open market immediately before the death

- the portion of the estate that is above the nil rate band would be taxed at 40%

How does HMRC use cumulation to adjust NRB?

- all transfers made in the last 7 years are considered as a sum when considering what comes under the band, rather than individiually

e.g., two gifts, £100,000 and £50,000, his cumulative total on death is £150,000

£150,000 will be deducted from £325,000, so his new basic NRB is £175,000 - anything above this will be taxed

What are the steps for calculating IHT on a failed PET or LCT?

1. Identify value transferred

2. Apply exemptions & reliefs

3. Identify chargeable value

4. Calculate and apply NRB

5. Apply rates of tax

(4 and 5 only apply when IHT is calculated after death)

What are the steps for calculating IHT on a death estate?

1. Calculate cumulative total

2. Identify assets included in the taxable estate

3. Value the taxable estate

4. Deduct debts/expenses

5. Apply exemptions & reliefs to reduce some of the value of the taxable estate

6. Apply RNRB

7. Apply any transferred NRB and RNRB

8. Apply basic NRB and calculate the tax!!

What is included within the taxable death estate?

property T was beneficially entitled to at the date of their death (inc property overseas)

includes:

- jointly owned property

- property subject to a reservation

- donationes mortis causa

- statutory nominations

- some interests in possession

does not include

- interests in a discretionary trust

How is jointly owned property taxed?

tenants in common: T's share of the property passes into the succession estate and into the taxable estate

joint tenants: although the surviving owner(s) receives T's share, for tax purposes, T's share of the estate will be included in the taxable estate.

key point: what should you be alert to when a property is held as joint tenants?

- it means T's share will go to the person they held it with, regardless of explictly stated beneficiaries in the will

e.g., T holds property with husband as JTs. States in their will that their estate will go to their son. The share in the house will still accrue to the husband!!

therefore:

- be aware of potential for spousal exemption for the share in these cases!!!

- this will affect whether RNRB will apply!!!! in the above example, RNRB would not apply

What is property subject to a reservation?

- T gives asset away in their lifetime but continues to use it, e.g., continues to live in the house

- treated as still part of their taxable estate for IHT purposes

How can someone avoid GROB (gift with reservation of benefit) rules?

- stop benefitting from the gift

- pay market rent for its use

Are Donationes Mortis Causa included in the IHT estate?

Yes

are statutory nominations in the (a) succession estate? (b) taxable estate?

not in the succession estate, but are in the taxable estate

What is an interest in possession trust?

- gives a named beneficiary an immediate right to the trust's income, such as rent from a property or investment dividends

- the life tenant receives income but capital is preserved for the remainderman who inherits after life interest ends

Are interest in possession trusts created BEFORE 22 March 2006 included in the life tenant's estate for IHT purposes?

- yes

- and is still the case for trusts created before 22 March 2006

Are interest in possession trusts AFTER 22 March 2006 included in the life tenant's estate for IHT purposes?

- capital value of the trust is included in life tenant's taxable death estate.

Which are the only assets not included in the taxable estate? (and if remainderman dies before life tenant, does their interest pass on?)

interests in discretionary trusts

examples:

- remainder interest in a life interest trust (if remainderman dies before life tenant, interest will not pass on)

- insurance policies that benefit a third party

- discretionary pension schemes

How are listed shares valued for IHT?

- Use the lower of the prices given on the Stock Exchange Daily List plus 1/4 of the difference between them.

How is 'related property' (e.g. matched assets owned by spouses) valued for IHT?

each party's share is valued at their proportionate share of the combined pair.

How is joint land (TiC or JTs) valued for IHT?

- value of the deceased's share is reduced (by 10%-15%) to reflect the difficulty of selling a share of the property rather than the whole

- applies to both TiCs and JTs

- deduction does not apply if co-owners are married

- applies to land, does not apply to jointly owned chattels

What debts can be deducted from the taxable estate?

- The deceased's debts due at the date of death eg outstanding credit cards bills

- the only post death debt that can be deducted are reasonable funeral expenses and the cost of a tombstone.

What exemptions and relief apply to calculate IHT on the death estate?

- Spouse exemption

- Charity exemption

- Business property relief ('BPR')

- Agricultural property relief ('APR')

Can the TNRB be claimed for multiple spouses?

Yes

- but the total transferred is capped at 100% of a full NRB.

When must the TNRB be claimed?

By the personal representatives (PRs) within 2 years of the end of the month of the surviving spouse's death.

What conditions must be met for the Residence Nil Rate Band?

there must be a qualifying residential interest (QRI) inherited by direct descendants.

What is a qualifying residential interest (QRI)?

- will be T's home or intended home

- investment property will not apply

Who counts as 'direct descendants' for RNRB purposes?

- Children

- grandchildren

- great-grandchildren

- adopted, step, foster, and those under guardianship

- spouses/civil partners of these descendants.

What is the maximum RNRB amount?

£175,000 (can be transferred and combined up to £350,000).

Can unused RNRB be transferred to a surviving spouse?

Yes

- surviving spouse must have died after April 2017 and must then leave QRI to a direct descendant

- can apply to a different home

How much RNRB will be available if T's interest in the property was less than £175,000?

will apply up to the value of the interest

e.g., the house is worth £150,000, will apply up to £150,000

What must you be alert to if the estate is worth more than £2m?

tapered withdrawal of Residence Nil Rate Band

How does tapered withdrawal work for RNRB?

- For estates over £2 million, RNRB reduces by £1 for every £2 over this threshold

- no RNRB at £2.35 million (£2.7 million with transferred RNRB).

What is the downsizing addition to RNRB?

an estate can get the value of full RNRB if T gave away the house or downsized to a less valuable house

amount of the addition to RNRB is calculated based on the old, larger house

What are the conditions for receiving the downsizing addition to RNRB?

These conditions must be met:

- T has given away their home or downsized to a less valuable home where value is less than the value of max RNRB

- happened on or after July 2015

- former home would have been a QRI if it had been retained

- direct descendant inherits the new, smaller home

When must claim for downsizing addition to RNRB be made?

- claim must be made by PRs within 2 years of end of month of death

What is the maximum combined NRB an estate can qualify for?

Up to £1 million (basic NRB + RNRB from both spouses).

e.g., Surviving spouse inherits unused NRB and RNRB from deceased spouse, giving them £500,000 each, totaling £1 million.

LIFETIME TRANSFERS

When will tax be due on lifetime transfers?

- tax due on an immediately chargeable lifetime transfer (LCTs only)

- as a result of the transferor dying within seven years of making a lifetime transfer (LCTs and failed PETs).

How do potentially exempt transfers work?

- no IHT payable when the transfer is made

- will become fully IHT exempt if transferor survives for the next 7 years

- if transferor dies within 7 years, PET 'fails' and becomes a chargeable transfer

How to lifetime chargeable transfers work?

- IHT is payable at 20% when the transfer takes place

- if transferor survives 7 more years, there is no further charge to IHT

- if transferor dies within 7 years, the transfer will be taxed at the death rate

What are the steps for calculating IHT on lifetime transfers?

1. calculate cumulative total (what is already in the beaker)

2. Identify value transferred (what is in the wine glass)

3. Apply exemptions and reliefs (reduce amount before pouring wine glass into the beaker)

4. Apply basic NRB and calculate tax

if calculating after death:

5. Apply taper relief

6. Give credit for tax paid in lifetime

What is the cumulative total for lifetime transfers? (1/5)

- calculated by adding up the value of all chargeable transfers made in the 7 years prior to the transfer (not just the 7 years prior to death)

How do you identify the value transferred? (2/5)

value = loss in value to the donor at the date of the transfer

How do exemptions apply to lifetime transfers?

- reduces the amount of chargeable value

- e.g., value of the transfer was £10,000, exemptions of £5,000 apply, so now value of the transfer to be taxed is £5,000

Which exemptions and reliefs are applicable to IHT on lifetime transfers?

- Annual exemption - always considered, but will be applied last if more than one exemption applies

- Spouse exemption

- Charity exemption

- Family maintenance exemption

- Small gifts allowance

- Normal expenditure from income

- Marriage exemption

- Business property relief

- Agricultural property relief

- Taper relief

How does annual exemption work?

- transfers of up to £3,000 per tax year are not chargeable

- once current year's AE has been used up, any part of the previous year's AE which was not used can also be claimed.

- apply other reliefs first, if they apply

e.g., marriage exemption, then this year's AE, then last year's AE

How do you apply basic NRB to lifetime transfers?

1. establish the value of the NRB

2. Reduce the total NRB by the value of the cumulative total

3. Apply a rate of 0% to the value of the remaining taxable estate up to the total NRB amount.

4. Apply the relevant rate to the rest to establish the IHT due.

How do you calculate cumulative total?

- earlier PETs that have not failed will not be taken into account

What NRB will apply to lifetime transfers?

- NRB applicable to an LCT when it is first made = NRB at the date of the transfer

- NRB applicable to a failed PET or a re-assessed LCT = NRB at date of death

Does RNRB apply to lifetime transfers?

No, it never applies

What level of tax is due on 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.

What level of tax is due on LCTs that don't fail?

20% is paid at the date of the transfer, and no more tax is payable after death

How much IHT will be payable based on the amount of time between transfer and death? (taper relief)

transfer was 0-3 years before death = 100% of the usual 40% due

transfer was 3-4 years before death = 80% of the usual 40% due

transfer was 4-5 years before death = 60% of the usual 40% due

transfer was 5-6 years before death = 40% of the usual 40% due

transfer was 6-7 years before death = 20% of the usual 40% due

How is credit given for tax paid in lifetime?

- when LCT is reassessed, must factor in the 20% already paid

- deduct the sum already paid from that due as a result of death (after taper relief has applied)

- if this balance is nil, no tax to pay

- if the balance is negative, cannot get a refund from HMRC

Who pays LCT during lifetime?

- primarily rests with the donor.

- If the IHT is not paid by the due date, liability can pass to the trustees of the trust which receives the assets.

- in practice, payment is typically made using the settled assets (ie the trust fund) instead of the donor paying the IHT

How does grossing up work?

- If a donor pays IHT using their own funds their loss is effectively "assets settled + IHT liability".

- The amount of this figure is calculated by notionally increasing (grossing-up) the original value of the transfer.

- IHT payable is then calculated with reference to the grossed-up value not the value settled.

- means that more tax is due to HMRC, hence why trustees often pay themselves, from the trust fund

Who pays IHT on failed PETs and LCTs that have become chargeable after death? (this only applies to lifetime transfers)

1. the recipient is liable to pay the IHT with own money

2. if recipient does not pay, PRs will become liable, and CAN use assets from the death estate to meet lifetime IHT charge

Who pays IHT for transfer upon death?

PRs are liable

- this is paid from the residue of the estate

- unless there is a contrary intention in the will e.g., the recipient of the gift should have to pay the tax on it

- cannot give residue free of tax, as the tax will be taken from the residue!

When will IHT not be payable from the residue of the estate upon death?

for items that are within the taxable estate, but not within the succession estate

e.g., JT property, statutory nominations, trust assets, GROB, donationes mortis causa

Who will pay IHT for JT property, statutory nominations, trust assets, GROB and donationes mortis causa?

The person receiving the benefit (or the trustees for a trust)

1. JT property - surviving co-owner

2. statutory nominations - nominated beneficiary

3. trust assets - TRUSTEES - note exception here

4. GROB - lifetime donee

5. donationes mortis causa - lifetime donee