Inheritance Tax

Inheritance tax is payable on the estate of a deceased person. We find it is a tax which will affect most of our clients. Anne Hutchings wrote two articles for Chemist & Druggist on Inheritance Tax Planning and these are reproduced below.

How much are you leaving to the taxman - part 1 August 2003

Many pharmacists are unaware of the huge legacy they will be leaving the Inland Revenue when they die. With the recent surge in house prices the value of the family home can take many pharmacists into the inheritance tax (IHT) trap. However, with careful planning this tax can be completely wiped out.

The first step is to estimate how much you are likely to owe the taxman. To do this add up the current value of:

£

Home, including contents

Investment properties

Share portfolio, including PEPs and ISAs

Cars, boats, caravans etc

Cash and bank balances

Deduct liabilities - mortgages, loans, bills, credit cards ( )

Total net assets

Deduct current exemption (255,000)

Assets liable to tax

Tax bill charged at 40%

The above is only a general guideline and does not, for example, take into account business assets as special exemptions apply, life insurance or pension funds. It also assumes that the full £255,000 exemption is available, this may not be the case if lifetime gifts were made within 7 years of death.

There are many ways of reducing IHT, for the remainder of this article I will examine some of the gift reliefs and exemptions.

Lifetime gifts

You can make gifts of assets, cash, properties etc during your lifetime and as long as you live for at least 7 years after making the gift it will drop out of your estate. Unfortunately with tax there are usually exceptions to the rule and this is the case with IHT. The danger zones are:

	Gifts where you retain a benefit Be careful not to make gifts with a reservation of benefit. An example of this is where you give your home away but continue to live in it, this does not usually work for IHT purposes. In this instance the Revenue will treat you as though the gift had not been made. You can get around this rule if you have a property which you live in with your son or daughter and you make an unconditional gift of part of the property to them. For this to work you must both continue to live in the property and both pay your full share of the outgoings.
	Gifts to a discretionary trust These are chargeable to IHT immediately where they exceed the exempt amount of £255,000.
	Married couples where one is non domiciled Gifts between married couples are exempt from IHT with the rare exception of when one spouse is non UK domiciled and the other is UK domiciled.

There are some specific lifetime gifts which are totally exempt from IHT regardless of how long you live. The ones worth mentioning are:

	Annual gifts of up to £3,000. If the allowance is not used in one tax year it can be carried forward for one year only to the next year.
	Gifts on marriage of up to £5,000 by a parent and £2,500 by a grandparent.
	Gifts to charities and political parties.

Tip: Be careful if you are gifting anything other than cash that you do not trigger other tax liabilities such as capital gains tax. Generally assets given away will be treated by the Inland Revenue as having been disposed of at their current market value.

Wills

It’s estimated that nearly 70% of the population have not made a will. It is important to make a will not just because of IHT but also to ensure that your assets go to the people whom you want to benefit. To illustrate the point look at the following example:

Mr Patel has a home worth £500,000, a share portfolio worth £300,000, an investment property worth £150,000 and cash of £20,000. He dies leaving a widow, they do not have any children. Mr Patel's parents are still alive. Unfortunately Mr Patel did not leave a will so his estate will be divided under intestacy rules as follows:

Total assets		£ 970,000
Widow receives	200,000
Plus half the balance	385,000	585,000
Balance of estate goes to Mr Patel's elderly parents		385,000
Less inheritance tax (£385,000 - £225,000 exempt @ 40%)		(52,000)
Received by Mr Patel's parents		333,000

When Mr Patel’s parents die IHT will be payable again and this could be as much as £133,200 depending on the value of their other assets. When Mr Patel’s wife dies the tax on her estate will be (£585,000 - £255,000 exemption at 40%) £132,000. Therefore, in the above example the overall IHT which could be payable as a result of Mr Patel’s death without a will is £317,200.

If instead Mr Patel had made a will leaving everything to his wife there would have been no IHT liability when he died. However, when the wife died the inheritance tax on her estate would be £286,000 (assets £970,000 less exemption £255,000 taxed at 40%).

Married couples should consider the following:

	Look at equalizing their assets so that they can both utilize the £255,000 exemption in their wills.
	Owning properties tenants in common. Typically when property is purchased by married couples it is usually done as joint tenants. It is quite straightforward to transfer ownership from joint tenants to tenants in common and this will allow each spouse to leave their share of the property to someone other than their spouse.
	Make tax effective wills. The wills should include a clause providing for the inheritance tax nil rate band (currently £255,000) to be left to a discretionary trust. This type of trust is very flexible and which assets are actually transferred can be decided on after death. However, because of the IHT legislation you would normally try and avoid transferring the family home into trust. The benefits of the trust are that the surviving spouse can benefit from income arising in the trust throughout his/her lifetime, but without the capital value of the assets falling into the estate of the surviving spouse. However, if necessary the capital in the trust can be transferred to the survivor, although in these circumstances the IHT saving will be lost. Providing the surviving spouse’s interest in the trust remains only discretionary, the capital value of the trust will not form part of the survivors' estate for IHT. This type of nil rate band discretionary trust will reduce the IHT liability by £102,000 based on current rates of tax.
	In conjunction with a tax efficient will a simple and often inexpensive way of eliminating any additional IHT may be to take out a life insurance policy on a joint life second death basis. Assuming both spouses are in reasonably good health and don’t smoke it may be possible to obtain the cover for just a few £'s a month. As a general point all life insurance policies should be written in trust. This is a simple process and your independent financial advisor (I F A) should be able to do this for you. The benefit of this is that the insurance monies will then fall outside your estate and not be counted for IHT purposes. Also the money can be made available very quickly following death.

How much are you leaving to the taxman - part 2 August 2003

Just as a quick reminder, inheritance tax (IHT) is payable on death, based on the value of the deceased’s estate at a rate of 40%, after various exemptions. The main exemptions are the first £255,000, (assuming it has not been used during the individuals lifetime), transfers to the deceased’s spouse and business property relief.

The family home is a major asset for most pharmacists, but unfortunately when it comes to inheritance tax (IHT) there is no exemption. The value of the property is added to the other assets in the individual’s estate and charged to IHT accordingly. The family home accounts for over 40% of the IHT collected by the Inland Revenue.

For example Mr Jackson a retired pharmacist died leaving his home worth £450,000 and some cash and shares worth £150,000 to his son. Sadly there is another beneficiary, the taxman. The IHT would be:

Value of the estate £ 600,000

Less IHT exemption 255,000

Amount liable to IHT 345,000

Inheritance tax charged @ 40% 138,000

How can IHT on the family home be avoided?

During his lifetime, Mr Jackson could have moved out of the property and then given it to his son. As long as he lived for 7 years after making the gift it would be tax free. It would not work for IHT purposes if Mr Jackson had continued to live in the property, the Inland Revenue would disregard the gift. This is because of the reservation of benefit rule whereby if you gift an asset but retain a beneficial interest in it the transaction is ignored for IHT purposes.

Mr Jackson could have given the property to his son and continued to live in it if he then paid his son a commercial rent. The rent payment would also help to reduce the value of Mr Jacksons estate for IHT. There is a possible downside to this depending on the recipient’s circumstances and that is the recipient would be liable for tax on the rent.

Mr Jackson may have been able to avoid IHT on the family home by creating a long lease over the property which became effective in the future in say 10 or 20 years. The lease would have been gifted into trust with Mr Jackson and his son as beneficiaries. As it gets nearer to the time when the lease commences the value in the freehold will have reduced. If the timing was right at Mr Jacksons death his value in the property will have substantially diminished. This could have taken the value of his estate to under the £255,000 IHT threshold. There are a number of schemes around involving trusts. However, the Revenue do tend to challenge many of these schemes so expert up to the minute advice should be taken before embarking on this type of more adventurous tax planning.

Business exemptions

Pharmacists who own their own businesses should qualify for business property relief. Generally if a pharmacist runs his/her business through a company the shares in that company should be exempt from IHT. Also if the pharmacist owns business premises which the pharmacy occupies there is a 50% IHT exemption.

Pharmacist Miss Casey died last November. She had operated her business through Casey Chemist Ltd for many years The company was valued at £950,000 when she died. In addition she owned the freehold of the business premises valued at £350,000. The IHT position is:

Casey Chemist Ltd – shares worth £ 950,000

Business premises owned personally 350,000

1,300,000

Less IHT exemptions:

100% on company share value 950,000

50% on business property 175,000

Liabile to IHT 175,000

IHT (assuming £255,000 exemption used against other assets) 70,000

Tip: If Casey Ltd had owned the business premises there would have been no IHT liability. This is because Casey Ltd which was an unquoted company owned by Miss Casey qualified for 100% exemption. This can be a reason for maximizing the value of a company by including qualifying assets in it such as the trading premises. However, the IHT position should not be isolated, it is also important to consider capital gains tax issues which are beyond the scope of this article. In addition the pharmacists’ long term objectives must not be overlooked. Sometimes it can be more flexible for pharmacists to own the business premises personally so that after the business has been sold the premises are retained to provide rental income in the pharmacists’ retirement.

Pharmacists who trade as sole traders or partnerships can also qualify for the 100% business property IHT exemption.

There are conditions which need to be met in order to qualify for the business property relief. I will briefly outline the main ones applicable to pharmacy businesses.

The business must be trading with a view to profit, this condition should be easily met. However, if substantial investments have been built up in, for example, the pharmacists trading company this may disqualify the company from business property relief. It is not uncommon for pharmacists to build property and share portfolios using the funds in their companies to do so.

To qualify for business property relief the business asset must have been owned for a minimum of two years.

When a pharmacist sells their business they should review their potential IHT liability as their circumstances will have changed. They will no longer have part of their estate qualifying for business property relief so the potential IHT on their death will increase, sometimes dramatically.

Mr Patel sold his pharmacy business for £500,000. Prior to the sale the business qualified for 100% business property relief. After the business was sold Mr Patel had cash of £500,000.

If Mr Patel had died just before he sold the business, or just after he sold it the IHT position would be:

Death before the sale – Business worth £ 500,000

Business property relief 500,000

IHT Liability NIL

Death after the sale - Cash of 500,000

Full amount liable to IHT (assume £255,000 general exemption used against the pharmacists
home and other savings)

IHT payable at 40% 200,000

Tip: When making a Will, leaving business property to a spouse means that business property relief is wasted. It would be preferable from a tax planning perspective to leave business assets to the children.

The legislation is complicated and the interaction of other taxes such as capital gains should be considered so it is vital to take professional advice.

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