As property values continue to rise and tax thresholds have not always been adjusted for inflation, the number of families affected by Inheritance Tax (IHT) has steadily increased.
While the HMRC has introduced several exemptions to permit families to give away more of their assets without incurring IHT, the rules governing the exemptions are complex and often confusing. Here are four areas where the intricacies of the exemptions can not only be problematic but also have caused more families to pay IHT.
Frozen nil-rate band
An individual can leave an inheritance of any amount to a spouse or civil partner on a tax-free basis. However, there are limits to tax-free bequests to other heirs. That amount, called the nil-rate band, has remained at £325,000 since 2009. Had the nil-rate band been indexed to the inflation rate, the threshold would now be about £423,000.
Confusing residential nil-rate band
In 2017, HMRC introduced the residential nil-rate band. Individuals can use this additional allowance to decrease their IHT liability if they are bequeathing their primary residence to a direct descendant, which is defined as their children, grandchildren and their respective spouse, civil partner or widow. This allowance will gradually increase up to £175,000 in 2020/21. However, there are complexities to using this allowance, and individuals should seek professional tax advice if they are unsure of its application to them.
Changes in the non-domicile rules
The changes in the non-domicile rules in 2017 can subject more families to the IHT. Individuals who permanently relocate from the UK now must live abroad for four years rather than three years to avoid being subject to the IHT. Also, UK residents who were born outside of the country are now considered to be domiciled in the UK after they live in the UK for 15 of the last 20 tax years rather than for 17 years.
Frozen gifting exemptions
Individuals can give away as much money as they want as long as they survive within seven years after making the gift. There is a £3,000 annual gift exemption from the IHT, and there is a one-year carryover allowance for that exemption. However, the £3,000 exemption has not changed since 1981. If it had been indexed to the rate of inflation, the exemption would now be worth about £11,100.
Reducing IHT exposure
As you can see, the issues associated with the IHT can be tricky, but as we point out in our guide called A Clear Approach to Tax Efficient Investing, there are steps that you can take to reduce your IHT bill. We recently joined the Adviser Hour panel discussion on IHT. Subscribers to GrowthFunders can watch the whole discussion here.
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