How do you avoid the kids inheriting a tax headache? (Birmingham Post article 25.07.2019)

The Office of Tax Simplification (OTS) has described inheritance tax as appearing to be “almost uniquely unpopular”.

Why is it so hated? Because it is seen as double taxation, levying a death tax on assets built up from taxed income through life.

No wonder then that both Conservatives and Labour have been looking to do something about it.

The former’s reforms, driven by fears about family homes being caught in the net, with unfortunates facing a 40 per cent tax bill, are gradually being implemented which means that from next April parents will be able to pass on an estate, that includes their main home, worth a total of £1 million tax-free.

In contrast, the latter seems to be edging towards complete abolition.

The Labour-commissioned Land for the Many report instead advocates a lifetime gifts tax of £125,000, above which income tax rates would apply. So, a typical couple leaving everything to their two children could see them able to inherit just £250,000 tax-free.

This is not yet Labour policy, but asked about it recently shadow chancellor John McDonnell backed the idea.

Meanwhile, requested in January last year by Chancellor Philip Hammond to carry out a review, the OTS has come forward with its own proposals.

Perhaps the most significant is that family members should be allowed to give away as much money as they like, tax-free, as long as they live for five years – not the current seven. At present, if a taxpayer dies within three to seven years of making a gift, IHT is paid on a sliding scale. But the OTS said this was too confusing. In addition, it believes tax-free gift allowances are poorly understood. Individuals can give away £3,000 a year without paying IHT, even within the seven-year window, and make unlimited gifts of £250 to other people. The report proposed increasing these annual caps to £11,900 and £1,010 respectively.

Given political expediency tends to trump sensible policymaking every time, it is likely that any such changes are a long way off, even if they are ever implemented.

Where then are we in the here and now?

One of the more unused IHT reliefs is the regular gifts from income exemption. If you have excess income you can make regular, planned gifts of the excess to anyone as long as it doesn’t affect your standard of living. This relief can also be used to fund premiums on a whole of life insurance policy written in trust. The idea is that on death the policy will pay out into trust, so it is outside of your estate, and the proceeds can be used to pay the IHT bill.

Gifts into trust can also reduce IHT on an estate, again under the seven year gifting rule. The trust structure allows the donor to retain some control over the assets during their lifetime, as long as they don’t benefit from it. The trust can be used to provide for beneficiaries, usually children and grandchildren, at some point in the future, so it is also a useful tool for inter-generational wealth planning. Trusts can have complex tax rules so it important that you get professional advice.

Investments in unlisted companies or those listed on the Alternative Investment Market qualify for full IHT exemption under Business Relief after two years holding. Agricultural land and forestry qualify for similar reliefs from IHT. Indeed, wealthy individuals have been buying up farmland by the bucket load to benefit from this without ever getting their hands dirty!

Well worth exploring even if IHT is set to remain a political football for the foreseeable future.