It is heavily mooted that Rishi Sunak is going to announce that he plans to significantly reform or possibly abolish inheritance tax (“IHT”). This is likely to be a talking point for quite some time. Therefore, we have provided some context to the potential reform below.
IHT is levied on the death estate according to the deceased’s domicile and the location of the assets within the estate.
Broadly, IHT is levied at 40% on the value of the chargeable estate exceeding the nil rate band and the residence nil-rate band, if available. Combined these allowances could total £500,000 and as allowances are transferrable between spouses, a married couple could pass £1 million to their children without a charge to IHT.
IHT can be mitigated through a number of tax planning techniques, whether that be simple gifts (survive 7 years and there is no IHT tax to pay) or using a Trust to hold a substantial Family Residential Estate. Furthermore, there are assets that qualify for full relief, including shares in an unlisted trading company.
It should also be noted that, on death, the underlying assets are transferred to the recipients at market value i.e. if the estate is less than £1 million, the children could immediately dispose of the Estate and realise no capital gains.
The objection to IHT usually stems from the concept that income earned can be taxed twice i.e. subject to income tax when earned and later subject to IHT when passed to the next generation. There are provisions to stop this double taxation where excess income may be gifted without a charge to IHT (even if the individual passes away within 7 years). However, given uncertainty and the cost associated with care, there is an understandable reluctance to risk gifting ‘excess’ income.
In theory, IHT is designed to catch the unrealised gains and to stop wealthy estates passing from generation to generation without those gains ever being crystallised.
The current system doesn’t support this ideology.
Broadly, effective IHT planning will mitigate exposure to IHT and the wealthiest estates have the money and flexibility to undertake that planning. The estates affected by IHT are those of the individuals who have found themselves with homes that have tipped over the threshold due to inflation and with relatively modest savings that they set aside to support themselves in the later stages of their lives.
If IHT is abolished, there needs to be an effective replacement whether that be a gift tax like many other jurisdictions or at the very least, the removal of the rebasing at transfer. However, there could be even simpler solutions, including increasing the nil-rate bands in line with inflation (they haven’t increased since 2009, although the residence nil-rate band was introduced in April 2017) or applying capital gains tax at death instead.