Inheritance Tax: 4 Common Mistakes That Could Cost You Thousands | Personal finance | Finance
As Inheritance Tax (IHT) revenues continue to rise, more and more families are caught in the net. Senior partner at national law firm Weightmans, Sally Cook spoke exclusively to Express.co.uk about the most common tax mistakes she sees clients make that can end up costing thousands of dollars. She explained that there are four main areas that people often overlook when it comes to estate planning, which can lead to significant IHT issues down the line.
Ms Cook recommended people always seek the professional support and advice of a lawyer when it comes to each individual estate plan.
She said: “It will give you confidence that you are avoiding potential pitfalls and that you have plans that will get you what you want to happen to your money in the most tax-efficient way. .”
Gifts with profit reserve
Ms Cook said: ‘One of the most common problems that can arise is that people give lifetime gifts of property and/or assets in the hope of gaining value outside of their estate to IHT purposes by surviving the gift date for seven years, but they will either continue to benefit or later benefit from this asset in the future.
“This is treated as a ‘gift with reservation of benefit’ by HMRC and the value can still be aggregated with the estate of the deceased even if they no longer own the asset.”
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She gave an example where parents give their children a vacation or second home but continue to use the property, rent-free. Simply, the fact that they are still using the house without paying open market rent means that HMRC will treat them as having reserved an advantage in the property and the value will still be aggregated with their own estate if they die within seven years. following the gift with reservation.
She continued: “Failure to comply with retention of benefits rules may in fact mean that the asset may be ‘double taxed’. In the example above, if the children were to die while their parent(s) were alive, the value of the property would also be considered part of the children’s estate for estate tax purposes as well. than that of their parents.
“The bottom line here is that if you’re considering donating an asset, you need to be very careful about how you use and interact with that asset in the future to ensure you don’t violate IHT rules.”
Used Goods Tax (POAT)
She also mentioned cases where people try to give away certain types of assets — including land and personal property — to get the value of those assets from their estate. However, such persons are deemed to benefit or be able to benefit from these assets and must pay income tax accordingly.
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In her example, Ms Cook said: ‘Let’s say person A donated £350,000 in cash to person B, and person B then used the money to buy a house. If Person A then moves into that property – and lives there rent-free – they will be subject to what is known as “second-hand property tax” from the time they move in. The tax is charged against the income it would otherwise have received. if they had rented the property at market price in the first place.
“Again, you must be very careful how you interact with the money or assets you donate. The rules on POAT are complex and it is important that you seek qualified professional advice to avoid an obligation. involuntary tax”.
Acts of amendment
Deeds of amendment are “often overlooked” in general estate planning, even though they are an effective way to obtain significant value from an estate for IHT purposes, she explained.
It is possible for a person who has benefited from a will or an intestate from a deceased person to redirect all or part of this inheritance to the person(s) of their choice. If done by official deed within the relevant time frame (within two years of the death of the deceased), it is not necessary for the donor of the gift to survive seven years for this gift to be outside his own estate for the purposes of the IHT.
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She added: “The problem is that people forget to complete the required documents before it is too late. If you know it’s something you want to do, it’s important to do it before making the donation, within two years of the death, and to make sure it’s done by official deed that contains the relevant declarations. for inheritance tax and capital gains tax. .”
“The 14-Year-Old Shadow”
Many people are familiar with the “seven-year rule” for IHT – IHT is not payable on an outright gift to one or more individuals if the donor has not reserved an advantage in the donated asset and survives seven years after making the donation.
However, many people are unaware of the so-called “14-year-old shadow.” This is relevant where a deceased has made “paid lifetime transfers” as well as outright gifts to individuals. This can be seen in the example below.
Ms Cook explained that if someone wants to gift £150,000 to their family, but still wants control over how and when it is used, they can decide to place it in a trust.
This would be a billable lifetime transfer for IHT purposes. Six years later they decide to give another £300,000, but they don’t put it in a trust – they give it directly in cash this time. Four years later, they die.
Ms Cook said: ‘In terms of calculating the IHT, the cash gift they made was within seven years of their death, so the value of that gift is still in the deceased’s estate. even if the asset was sold four years before the death. .
“Every individual in England and Wales has a ‘zero rate band’, which is basically an amount they are allowed to give away, when and how they want, tax free. If the cumulative total of all donations made within seven years of their death is less than or equal to this amount, there is still no tax to pay.
The standard zero rate band for 2022/23 is £325,000 for a single person. To calculate the portion of the zero-rate bracket available to offset all donations made in the seven years prior to death, people must first subtract the value of any “billable lifetime transfers” made within seven years of death. first cash donation failed.
In Mrs. Cook’s example above, the £150,000 that was placed in trust reduces the zero rate bracket from £325,000 to £175,000, which does not cover the £300,000 that was offered in species. The recipient of this failed cash donation will be personally liable to IHT at 40% of £125,000, or £50,000.
She concluded: “It illustrates how complex this planning can be and the importance of ensuring you have taken advice on how the interaction between different types of lifetime giving could affect the tax position. Taking professional advice from a lawyer here is key. They can help you understand.”