In recent years, more and more people have fallen into the inheritance tax (IHT) net, largely owing to house price inflation and overall growth in individual wealth. Unlike income tax, there is no incremental scale for IHT. So if your estate is worth up to £275,000, you pay no tax. Anything over that amount and you could potentially pay 40 per cent on it – for example a £300,000 house could incur IHT of £10,000. 

In the 2005/06 tax year, HM Revenue & Customs received £3.4bn in IHT compared with just £1.68bn in 1997/98 (Source: HM Revenue & Customs 2006).

Another contributory factor has been the closure of many loopholes in tax planning, with stricter enforcement of existing legislation. New rules on pre-owned assets have sought to clamp down on people giving away assets to heirs while still benefiting from them.
Although there are now fewer ways to reduce the tax paid on estates, some legitimate options are still available; however, taking professional advice is crucial with such schemes.

Marriage allowances

Any inheritance by a spouse is not subject to IHT, and this exemption also now covers same-sex couples who are registered as civil partners. It does not cover co-habiting couples.

Using the nil-rate band

Most people leave all their assets to their wife or husband in the knowledge that there will be no IHT to pay. But this means that when the second parent dies, anything left in their estate above the nil-rate band could be subject to IHT. One potential option is to make use of the nil-rate band using a nil-rate band discretionary Will trust when the first parent dies, rather than waiting until both expire.

To set up a Will trust, the property must be owned as ‘tenants in common’, not the more usual ‘joint tenants’, which is the way most married couples hold the family home. Each partner then writes a Will leaving their half-share of the property to the children or grandchildren or other beneficiaries.

Both partners also complete an ‘Expression of Wishes’ document, which states that the deceased person would like the surviving partner to remain in the property for the rest of their life. To avoid a challenge by HM Revenue & Customs, the Wills must not give the surviving spouse an absolute right to remain living in the property until they die. If this is written into the Will, Revenue & Customs could argue that there is an ‘interest in possession’ and IHT may not be avoided.

IOU schemes

This is a version of the nil-rate band discretionary Will trust. But rather than placing half the family home in trust, a debt is created, with the surviving spouse buying out the deceased partner’s half of the property. This IOU is placed in the trust and is repaid from the sale of the home on the death of the second partner. As the trust owns a debt, rather than an asset, there should be no problem with how the benefits are divided between the beneficiaries. It also ensures both partners’ nil-rate bands are used.

This type of arrangement does not go against current HM Revenue & Customs rules and is therefore less likely to be contested. When the homeowners die, the loan is repaid from their estate. If both spouses make full use of the nil-rate band they could escape paying tax on £550,000 of their assets.

Any tax planning scheme needs a lot of thought, as HM Revenue & Customs are taking a very close interest in all the different tax mitigation schemes around. You should always obtain professional independent advice to ensure that the scheme structure is set up correctly and does not fall foul of the rules.

If you would like to find out more about the tax saving strategies that may benefit your situation, please
e-mail or contact us for further information.

Levels and bases of, and reliefs from, taxation are subject to change.