Inheritance tax in the United Kingdom

In the United Kingdom, Inheritance Tax was first introduced as a tax on estates in England and Wales over a certain value from 1796, then called legacy, succession and estate duties. The value changed over time and the scope of estate duty was extended. By 1857 estates worth over £20 were taxable but duty was rarely collected on estates valued under £1500. Death duties were introduced in 1894, and for the next century were effective in breaking up large estates.

Currently, 94% of all estates escape Inheritance Tax, mainly because they fall in the nil rate band

Inheritance tax

Estate duty was replaced in 1975 by Capital Transfer Tax, which was rebranded Inheritance Tax (IHT) in 1986. Partly due to the simple and widely-used methods which are available to avoid it, Inheritance Tax accounts for about 0.8% of government income, raising around £2 billion in 2001 and £3.6 billion in 2006.

For the 2007/2008 tax year, the IHT rate is 0% on the first £300,000 (the "nil-rate band), and 40% on the rest of the value, at death, of an individual's tax estate. The nil rate band rises annually; tax is only payable on the value of an estate above the nil rate band. For example, all other things being equal, an individual whose estate is £354,000 (the mean London house price in 2007) will pay IHT amounting to 0% of £300,000 plus 40% of £54,000 i.e £21, 600 in all. This is 40% of the amount over the nil rate band, but in this example, 6.1% of the total value of the estate. Those whose estates match the average nation-wide house price of £210,000 will pay zero IHT.

In the 2007 budget report the Chancellor announced that the nil rate band is to rise to £350,000 by 2010. This is to take into account the sharp rise in house prices in the United Kingdom over the past few years.

Tax estate

The tax estate includes:

1. all of the deceased's assets, whether real estate or personal estate, and includes even small-value items such as the contents of his or her home;
2. any gifts made by the deceased in the seven years before death;
3. some assets which were not owned by the deceased but which are affected by the death (the most common example is a life interest in a trust, technically known as an interest-in-possession);
4. gifts with reservation of benefit. These are gifts where the legal ownership passes to the recipient. However, the donor continues to enjoy the benefit of the asset either rent free or at reduced cost. The seven year period outlined above does not begin counting down whilst a gift is considered to be under a reservation of benefit.

There is also a charge on "lifetime chargeable transfers" into certain trusts (and a recalculation of those charges if the giver dies within seven years), and trusts themselves have an inheritance tax regime. See Taxation of trusts (United Kingdom).

Deductions

There are deductions for:

1. all assets left to a charity registered in the UK.
2. some political donations;
3. gifts of up to £3000 in total in a given year[1]
4. "small gifts" of up to £250 made to separate people;
5. some business assets (under Business Property Relief or "BPR");
6. some farmland (under Agricultural Property Relief or "APR").
7. gifts made out of income that do not impact upon the standard of living of an individual.
8. gifts made in contemplation of a marriage or civil partnership. The level of this deduction varies according to the relationship of the donor to person marrying or entering into a civil partnership.

Minimising IHT

In order to avoid IHT, many people in the IHT bracket practise some or all of the following avoidance measures:

• Outright gifts to another individual made during a person's lifetime are known as "potentially exempt transfers" or PETs. They are taxable if the person dies within seven years, but have the potential to become exempt from tax once seven years have gone by with the giver still alive. If the giver survives three years, the rate of tax on the PET reduces by one fifth (to 32%) and then by a further fifth on each of the subsequent anniversaries (to 24%, 16% then 8%) reaching 0% after seven years. This is known as inheritance tax taper relief (not to be confused with the better-known capital gains tax taper relief).

• Gifting assets to a trust fund before death. (Some gifts of this kind, however, are disadvantageous as they amount to lifetime chargeable transfers on which IHT is paid straight away if more than £300,000 is gifted. This applies to many more trusts than previously under legislation announced in the 2006 budget. See Taxation of trusts (United Kingdom).)

• Certain special types of trust, such as Discounted Gift Trusts and Gift & Loan Trusts, which allow for some planning whilst retaining some access to capital/income.

• Charitable giving, which is IHT exempt.

• Lifetime gifts within certain limits are completely exempt. These include any number of "small gifts" (up to £250), an annual amount of £3,000, all regular gifts from surplus income, and some wedding gifts.

• Upon death, passing non-taxable assets to the next generation (or to a discretionary trust for the benefit of the whole family) and therefore NOT to the spouse. To many people this seems counter-intuitive because they are aware that gifts to a spouse are IHT exempt and should therefore be maximised. However, if something is non-taxable on the first death it should not go to the spouse as it will merely increase his or her tax estate upon his or her later death. (The nil-band discretionary trust, discussed below, is an example of this principle in action.)

Inheritance tax allowances became transferable October 2007

The Chancellor's Autumn Statement on 9 October 2007 announced that with immediate effect inheritance tax allowances (often referred to as the nil rate band) were to be transferable between married couples and between civil partners. Thus, for the 2007/8 tax year, a married couple will have an allowance of £600,000 against inheritance tax, whilst a single person's allowance remains at £300,000

For example, if the first half of a married couple to die were to leave £100,000 to their children and the rest of their estate to their spouse there would be no inheritance tax due at that time, and later upon the second death the first £500,000 of the surviving spouse's estate would be exempt from inheritance tax.

This measure was also extended to existing widows, widowers and bereaved civil partners at 9 October 2007. So if their late spouse or partner had not used all of their inheritance tax allowance at the time of their death, then the balance of that allowance can now be added to the single person's allowance when the remaining spouse or partner dies.

Prior to this legislative change, the most common means of ensuring that both nil rate bands were used was called a nil band discretionary trust (now more properly known as NRB Relevant Property Trust*). This is an arrangement in both wills which says that whoever is the first to die leaves their nil band to a discretionary trust for the family, and not to the survivor. The survivor can still benefit from those assets if needed, but they are not part of that survivor's tax estate.

• Finance Act 2006

Pre-owned assets

The Finance Act 2004 introduced an income tax regime known as pre-owned asset tax which aims to reduce the use of common methods of IHT avoidance.

Criticism

Dr.Barry Bracewell-Milnes authored Euthanasia for Death Duties - Putting Inheritance Tax Out of Its Misery, which was published by the Institute of Economic Affairs in 2002.

In August 2006, former Cabinet minister Stephen Byers called for IHT to be abolished in an article in the Sunday Telegraph.[2].

On 16 October 2006, Philip Johnston, writing in The Daily Telegraph had a scathing leading article against inheritance taxes and called for David Cameron, new leader of the Conservative Party (UK), to announce the demise of a catch-all inheritance tax as a main plank in that party's next manifesto.

Are 'death taxes' evil?

Despite the, perhaps understandable, criticisms of taxes that occur when someone dies, it is accepted by many that it makes sense to tax people that can no longer use their money. In addition, it can have redistributive qualities, taking money away from those that can afford it and redistribute it. For example, The Economist published an article (The case for death duties) in October 2007 highlights this, but also acknowledges the political controversy it can cause, and suggests some ways to reform it.

See also

• History of the English fiscal system
• Disclaimer of interest (including Deed of Variation)

External links

• Revenue and Customs Inheritance Tax