Inheritance tax and spousal exemption: should it be extended? – Marilyn McKeever

Written by Marilyn McKeever, Partner at BDB Pitmans Law Firm

Inheritance tax (IHT) is probably the most hated tax. It is payable on savings made on taxable income and deducts a significant part of the inheritance that an individual may leave to his family on his death.

IHT is also not a significant source of income. In 2021-22, the tax raised £6.1bn: a meager 0.85% of total tax revenue of £718.2bn and 1.5% of income tax.

A brief summary of exemptions and reliefs

As a reminder, outright donations to individuals are tax exempt provided the donor survives seven years (but taxable if they don’t). Donations to trusts for young or vulnerable beneficiaries are problematic because they incur initial and ongoing tax burdens.

While the very wealthy can afford gifts for life, the majority of most people’s wealth is tied to their homes and retirement plans and their gift giving opportunities are limited.

The first installment of everyone’s estate is tax-free. The ‘zero rate band’ is still £325,000, a figure set in 2009 and frozen since, bringing many estates into the tax net due to tax drag.

A person who owns or has owned property and leaves it to their children or grandchildren in a will gets an additional £175,000 zero residency rate band, but this decreases if the total estate exceeds £2m.

Zero rate brackets can be transferred to a surviving spouse/civil partner so that the survivor can leave £1 million IHT free to their children or other beneficiaries.

Other people can donate a maximum of £500,000 excluding tax. Everything else is taxed at 40% unless relief applies.

The main IHT reductions are as follows:

· Businesses and farms are generally tax exempt;

· Donations to charities are exempt;

· Regular donations made from surplus income are exempt without limit (for life only); and perhaps most important of all

· Gifts between spouses and civil partners (“spouses”) are exempt without limit. (unless one of the spouses is not domiciled).

Can the spousal exemption be extended?

There have been attempts!

It is not uncommon for siblings to share a house or apartment. Property may be the primary asset in their estates and its value may well exceed the zero rate band, especially if it is in London or the South East. When the first sibling dies, the survivor may be forced to sell the property to pay inheritance tax, thus losing their home when they are most vulnerable. The elderly Burden sisters were in this

situation. In 2008, they argued before the European Court of Human Rights that they should enjoy the same protection against inheritance tax as a married couple. The Court, rejecting the claim, accepted the UK Government’s argument that the purpose of the exemption was to promote “stable and committed heterosexual and homosexual relationships by providing the survivor with a measure of financial security after the death of the spouse or partner“. The Court recognized that there could be difficulties in certain situations, but it was up to the government to decide “how to strike the best balance between raising revenue and pursuing social objectives”. Basically, it’s a policy issue.

The Office of Tax Simplification (OTS) also addressed the issue in its 2018 Inheritance Tax Reports, observing that cohabitants were in the same position as siblings. The OTS concluded:

“The OTS considers that any change to the definition of spouse to include a cohabiting partner or siblings would be far reaching. This would very naturally be part of a broader response to social change being considered across the government rather than being driven primarily by estate tax considerations.

HMRC figures for the 2019-20 tax year show the cost of the spousal exemption to the Treasury was £1.83billion. HMRC comments that the actual cost is considerably higher than this as not all estates need to provide full details. Even on these figures, the cost of the relief represents about a third of total IHT revenue, so the government is likely to be reluctant to extend it, whether to cohabitants (who have the option of marrying/ to associate civilly) or to brothers and sisters, who do not.

Despite this, Lord Lexden has just tabled a private member’s bill in the House of Lords to extend the gift exemption between spouses to siblings who have lived in the same household for seven years.

The bill would exempt gifts from one sibling to another of any property, during their lifetime or by will.

It goes beyond the issues identified as arising from the death of a brother and it seems unlikely that the government has much sympathy for the proposal.

Conclusion

Nothing is certain except death and taxes, and when it comes to inheritance tax, they often coincide! With good planning it is possible to help your clients mitigate the impact of IHT and the sooner people seek advice the better.

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