What can your older parent can do about Inheritance Tax
Are there legitimate things your Parents can do to avoid Inheritance Tax?
Former Chancellor of the Exchequer, Roy Jenkins, once said, “Inheritance Tax is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”!
Whilst the rules have been tightened-up somewhat since he said this, there are certainly many things that can legitimately be done to reduce the burden of Inheritance Tax.
Often, Clients approach me worried about the impact Inheritance Tax (IHT) might have on their family’s eventual inheritance.
However, with the 2013/14 threshold at £325,000 for an individual and £650,000 for a couple, this is not an issue for very many people
In fact, in 2009/10, only 3% of estates dealt with by Probate Registries resulted in any Inheritance Tax being payable (Source: HMRC 31 July 2012)
What are the best ways to reduce my Parent’s Inheritance Tax bill?
If your Parents have a life-expectancy of at least 7-years and they can afford it, the most obvious way to reduce their Inheritance Tax bill is to give away some of their assets
There is no tax on your Parents or the Donee at the time of the gift, regardless of the amount, but the gift, known as a Potentially Exempt Transfer (PET)
However, the PET will be brought back into account for Inheritance Tax if your Parents die within 7-years
If your Parents don’t want to make an absolute gift, or it is inappropriate because of age, disability or family reasons, then wrapping the gift in a Trust can be just as effective
Putting money into most Trusts is not a PET but a Chargeable Lifetime Transfer and liable to Inheritance Tax at the lifetime rate of 20% if the amount put into Trust exceeds £325,000 per individual
Professional advice should always be taken before setting-up a Trust, so it is inappropriate to go into further detail here
A gift has to be absolute – giving-up all rights to the asset given away – to avoid being caught by the rules governing Gifts with Reservation of Benefit
However, there are a number of legitimate schemes that provide an element of “cake and eat it” by exploiting a legal device known as a carve-out, which was established in St. Aubyn v Attorney General [1952] and has stood the test of time
For example, the right to a future income can be “carved-out” before an asset is put into Trust and this does not fall foul of the reservation rules. As this type of planning involves the use of Trusts, professional advice should be sought
If your Parents have a life-expectancy of less than 7-years, but more than 2-years, then exploiting Business Property Relief is worth considering
By acquiring assets eligible for Business Property Relief and holding them for a minimum of 2-years, they are then effectively valued a nil for Inheritance Tax purposes. Access to the asset and/or any income generated is not restricted in any way.
There does, however, need to be an element of “enterprise” involved because this is the basis of the exemption, so there is invariably a higher degree of investment risk involved
I was taught many years ago to never allow the “tax tail to wag the investment dog” and this is very relevant in this context. Again, this is an area where relevant professional advice should always be sought
What are the illegal ways to evade Inheritance Tax that your Parents should avoid?
Here we enter the debate about the difference between tax avoidance and tax evasion and is something that is very topical following various high profile exposés, especially the comedian, Jimmy Carr
Let’s be frank, tax evasion always has been and always will be illegal and, consequently, is something that I never have been and never will be involved in
Generally, tax avoidance, where that is merely the legitimate exploitation of allowances and exemptions written into the legislation, is not only legal and legitimate, it is something the Government expects us to do (and is what Roy Jenkins meant). I use the word “generally”, because a whole industry has grown up around the exploitation of tax allowances and exemptions, resulting in schemes which, at best, sail a thin dividing line between avoidance and evasion
Such schemes have caused the Treasury so much concern that the Government has introduced DOTAS (Disclosure of Tax Avoidance Schemes)
Under this legislation many schemes, including those involving Inheritance Tax, have to be disclosed to HMRC, allowing them to find ways of “closing the loophole”
Widening this process has lead the Government to introduce GAARs (General Anti Abuse Rules), which are used effectively in other countries.
So, I would answer the question, “What are the illegal ways to evade Inheritance Tax that your Parents should avoid” by saying it’s anything that is not a straightforward exploitation of the allowances and exemptions. If it seems to be too good to be true, it probably is!
If there is one asset that people want to protect from Inheritance Tax, it is their home. However, it is virtually impossible to lift this asset out of the net of Inheritance Tax whilst still living in it and not offend the rules governing Gifts with Reservation of Benefit
A “Double Trust” scheme was marketed by a number of professional advisers 10-years or so ago and the Government enacted what was effectively retrospective legislation to defeat this
If your Parents give their home away you need to remember this is exactly what they have done – given it away
What happens if the person they give it to goes bankrupt, gets divorced or dies? Also, there is the issue of the loss of Principal Private Residence relief from Capital Gains Tax on a subsequent disposal
For the gift to be effective for Inheritance Tax purposes, your Parents would have to pay a commercial rent to the new owner(s) for the rest of their lives
After I’ve said that to a Client, the next words I often hear are, “That’s alright; they’ll just give it straight back”. Surprise, surprise, that’s tax evasion!
The bottom line here is, take professional advice.
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Clive Barwell TEP FCSI CFP is an accredited member of the Society of Later Life Advisers and uses his vast experience as an Independent Financial Adviser to provide a financial “satellite navigation” system to his Clients. Financial planning is all about establishing the current location, ascertaining the future desired destination, plotting a course, keeping to that course and avoiding the financial obstacles of life.
Clive can be contacted at http://www.clivebarwell.co.uk/contact/.
