Inheritance Tax: A Typical Case Study

Julie Kingham discusses a typical case for Inheritance Tax and the tax implications of giving away wealth, as well as ways of reducing the tax.

Meet Ben, Irene and their 2 children, Ross & Carley.

Ben started and built up his own business. In the early days Ben struggled – occasionally had to borrow to further expansion and pay staff wages – but all the worry paid off and now he owns a successful business which provides his family with a reasonable standard of living.

5 years earlier Ben was the sole beneficiary of his mother’s Estate and he received £500K in cash after IHT. He always knew that his mother wanted her grandchildren to benefit from her Estate so when Ross reached 21, Ben gifted him £250K. This is a PET (potentially exempt transfer) and on the date of this gift there are no inheritance tax consequences.

Carley, being less financially astute (and let’s face it more reckless with money than Ross) was a worry to Ben. He did not want to gift her £250K outright as the chances are that she would waste the money within a year or so. So, Ben settled the money into a discretionary trust for Carley – she was entitled to the income until the age of 30 when she would receive absolute entitlement to the capital. This gift – being a chargeable lifetime transfer was below Ben’s NRB and again no IHT was payable.

In the next year Ross joins the family business and proved to be an asset to the business. A younger more modern approach saw the business begin to grow.

Meanwhile Ben and Irene watched a TV program and decided to each makes a Will. They found a Will kit on the internet and produced 2 standard, simple Wills. On the first death all assets pass to the surviving spouse (no IHT as transfers to spouses are exempt from IHT) and on the second Will the assets are then passed equally to Ross and Carley.

Unfortunately, 18 months after making the gifts to his children, Ben died in an industrial accident at work.

His Death Estate consisted of:

Ben’s share of the family home £250,000
Holiday home £250,000
Share in his company £150,000
Cash and investments £100,000
Total £750,000

Under the terms of Ben’s Will, Irene inherits the above. As previously mentioned, there is no IHT to pay. Or is there?

The 7 Year Rule

As Ben died within 7 years of gifting cash to the children, both the PET and CLT have to be considered as follows:

PET to Ross £250,000
Less NRB £250,000
IHT Payable £0
CLT to Carley's Trust £250,000
Less Balance of NRB £75,000
IHT payable on £175,000 @ 40%
IHT Due £70,000

A couple of months after Ben’s death Irene moves her new younger boyfriend / lover, Drew, into the marital home. Ross and Carley are a bit upset about this but decide that it’s their mother’s life and she should know what she is doing. Irene does not change her Will – she is too busy enjoying life with a younger man.

A year after co-habiting with Drew, Irene dies – whether under suspicious circumstances is not relevant to our story.

So, under Irene’s Will her estate is left equally to Ross and Carley. Drew, being a co-habitee with Irene has no rights nor any claim to her Estate. Ross and Carley are left with organising Irene’s funeral – Drew is not involved. (Eventually, Ross and Carley evict Drew from the family home – he leaves with only the assets that he brought to the relationship. Nothing more, nothing less.)

Irene’s Death Estate consists of:

Total ownership of the family home now valued at £550,000
Holiday home £275,000
Share in his company £175,000
Cash and investments £50,000
Total £1,050,000
Less: Irene's NRB £325,000
Less: Irene's RNRB £125,000
Liable to IHT Taxed @ 40% £600,000
IHT Due £240,000

The Executor of the Will would need to pay £240,000 from the Estate, within 6 months of Irene’s death. Given there is not sufficient cash, this would mean a combination of the family home, holiday home and shares would need to be sold to raise the funds.

So, what could have been done to reduce the IHT charge?

Reducing the Inheritance Tax Charge

Ben could have originally left his shares in his company to Ross. These shares attract 100% BPR – therefore an IHT charge would not have arisen on this asset.

Ben could have also passed half his share in the family home (value £125K) to Carley – his RNRB of £125,000 would have been set against this - again leaving no IHT payable. Irene’s death estate would have been reduced by £275K – generating an IHT saving of £110K

Why on Irene’s death did the shares in the business not attract 100% BPR? Because she had not held them for 2 years up to the time of death.

And finally, there is another scenario to consider. What if Irene and Drew had married or entered into a Civil Partnership?

In this case, Irene’s existing Will would have become Null and Void. Her estate would have passed under the rules on intestacy. Drew would receive the first £250K and half of the remainder (£530K). Ross and Carley would receive the balance (£280K between them).

Conclusion

This demonstrates the need to prepare for the future to protect the assets that you have worked hard to create - and ensure that your Estate is left to those you wish to benefit from your hard work. Never underestimate the need for professional advice.

This example also illustrates why you should keep your Will up-to-date. It is possible for your beneficiaries to use a Deed of Variation within 2 years of your death to amend your Will, but only if all the beneficiaries agree to it.

Looking for Inheritance Tax advice?

Aspen Waite help individuals reduce their Inheritance Tax Liability with robust planning and strategies. To find out more about how you could save paying unnecessary tax, contact one of our advisors who will be happy to help.

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