Personal finance: how to avoid paying inheritance tax
It may not generate as much revenue for government coffers, but inheritance tax remains a thorny political issue – and it is expected to become even more so, as house prices continue to soar during the pandemic. In progress.
Some denounce inheritance tax as a form of double taxation, while others argue that it helps reduce wealth inequalities and improve public finances.
Indeed, the OECD recently argued for an increase in inheritance taxes as a way to help pay for supports in a pandemic – so it remains to be seen whether the government will heed the calls to raise the thresholds for tax exemption.
By OECD standards, Ireland has a relatively progressive inheritance tax system, although the threshold for children inheriting from parents is much higher than for those who are not direct descendants. The result is that the richer families are much more likely to inherit than the less well-off families.
Irish families can leave up to € 335,000 for each of their children before those children face a tax bill. But this figure drops to € 32,500 for other close relatives, and to € 16,250 for more distant relatives or friends.
The government defended this regime on the grounds that, since the family home is the main constituent element of an estate, a lower threshold would force children inheriting from a parent to sell it in order to face tax.
However, the relentless inflation in house prices has led a growing number of families, especially in Dublin, to face hefty Capital Acquisition Tax (CAT) bills as the houses they inherit – even the old ones. modest homes – worth much more than the tax exemption threshold of € 335,000.
The latest figures from the CSO show that households have paid a median or average price of € 265,000 for a house in the Republic over the past year, while in Dublin the median price was € 390,000.
In 2009, the tax exemption threshold was just over € 540,000. In 2015 it was reduced to € 225,000 and it has slowly risen since then.
There is no doubt that more people have found themselves in the net of inheritance and gift taxes. Income figures show that 16,000 people paid 522 million euros in 2019, more than double the amount paid by nearly 11,000 people in 2010.
So, what are the ways to avoid or reduce the gift or inheritance tax that may be payable on the assets you bequeath in the event of death?
Small gift exemption
It is well known that you can inherit up to € 335,000 from a parent in your lifetime without paying tax on them, and any amount above this threshold is subject to WCB at 33pc. Likewise, you can inherit up to € 32,500 tax-free from a close relative, such as grandparents, uncle or aunt or brother or sister, and up to € 16,250 from someone with whom you have no blood connection.
What is less well known is that you can gift up to $ 3,000 per year to anyone without having to pay CAT. Known as the small donation exemption, this also means that such donations of less than € 3,000 per year will not count towards the total inheritance that a person might receive before reaching their thresholds. parent-child tax exemption.
For example, a couple could give their daughter and her family up to € 30,000 per year if she has three children (€ 3,000 from each parent for daughter, son-in-law and three children).
“It’s the easiest way to manage gifts and estates if you have the foresight and the means to do it,” says Marian Ryan, head of consumer taxation at Taxback.com.
“When we see it commonly, it is in the parents, grandparents, and godparents who will purchase endowment or savings certificates in the child’s name in small amounts consistently throughout. of the child’s life, which can be a substantial amount when they reach 18 or 21 – but because they were less than 3K € per year, it is below the threshold, so no tax is owed on them.
“Other than that, I think the small gift exemption is underutilized.”
It should also be borne in mind that the gift should also not be in cash as long as it is worth less than € 3,000 – it can be jewelry, cars, stocks, for example.
Exemptions for residential houses
This is one of the many exemptions that could be claimed from the capital acquisition tax, but it would entail a slight change in lifestyle. It’s also more restrictive than before, as the rules were tightened in 2016.
Under this relief, if a child lives in the family home for three years before the gift or inheritance (and has no other property himself), then the parent can give it to him or her free of charge. tax, as long as the child then remains in the property for six years after surrender and does not own any other property during that period.
Some exceptions to the six-year rule are if you are over 65 when you inherit the property, or if you have to live elsewhere because of your job or because of a mental or physical disability.
If you are married or in a civil partnership and you die before your spouse, he will not pay any capital acquisition tax on all the gifts you give them. So this is a bit of an extreme move – but if you want to pass your property on to someone who is not your family member or life partner, you can legally marry them.
“We have heard, anecdotally, of single people entering into a civil partnership or a marriage in order to be able to bequeath an inheritance to their life partner or a good friend in order to avoid the heavy tax bill associated with it”, Ryan said.
Indeed, the case of two heterosexual friends, Michael O’Sullivan and Matt Murphy, who married in 2017 to avoid inheritance tax of € 50,000 on the house Murphy intended to leave to O ‘ Sullivan in his will.
What is most often done by non-blood-related people who want to donate or leave a legacy to someone is to take advantage of the exemption for small donations over a long period – if they have foresight, says Ryan.
Check out an item 72
There are insurance policies that you can purchase that will cover the CAT tax bill that could apply to anyone to whom you donate a large inheritance.
Known as the Section 72 policy, relief is approved by Revenue to allow people to cover the cost of taxes on death.
It is structured like a whole life insurance policy, but it is expensive. If a child who receives an estate faces a tax exposure of € 66,000 resulting from inheriting a house worth € 535,000, the monthly cost of underwriting a Section 72 policy of € 66,000 € from Royal London (for a non-smoker, 50 years old) would be € 93 per month, according to Joey Sheahan of MyMortgages.ie.
Another problem is that the policy must be paid, uninterrupted, for at least eight years before the proceeds are exempt from gift tax.
It could be something the children are encouraged to cover the cost of, as it will help them avoid taxes when they inherit.
How to benefit from the tax exemption for small donations
The small gift exemption looks like a valuable tax break, so why isn’t it more popular?
When it comes to inheritance tax, most financial advisers will be quick to recommend that everyone take advantage of the small donation exemption.
Thanks to this tax relief, you can offer up to € 3,000 per year to anyone, without having to pay the CAT (tax on the acquisition of fixed assets), and who does not count in the threshold exemption from cumulative inheritance tax for life.
But it is still an underutilized tax break in a way, as it can lead to practical and real issues that prevent it from being used more widely.
The first potential problem is liquidity, as your assets can be tied up in pensions or property, which means you can’t turn them into cash easily or quickly – but if you have instant access to your funds, it is definitely a great option.
Are there any limits that affect how the small gift exemption works?
You can offer up to € 3,000 each year to an unlimited number of individuals. For example, a child could receive € 18,000 tax-free each year from four grandparents and two parents.
There is no limit on the amount a person can receive in a tax year under the exemption, except that no more than € 3,000 comes from a single person. There is also no upper limit to the number of times you can use the exemption, and it does not matter whether your children are under or over 18 years of age.
Are there many forms to fill out or hoops to go through to claim small gift exemption?
Exploit the small gift full exemption for your children would require considerable intergenerational coordination and a few gentle “reminders”, which could get awkward. No one likes to ask for money, after all.
There are some savings plan products specifically designed around the small gift exemption that may be worth checking out, such as those from Irish Life or Standard Life.
It should also be borne in mind that the gift does not necessarily have to be in cash, as long as it is worth less than € 3,000 – it could be jewelry, cars or stocks, for example. Of course, if an individual item is worth more than $ 3,000, the balance of the value over that amount may reduce the beneficiary’s lifetime tax exemption threshold.
Is the will the small gift exemption tax break go to help your kids buy a home?
If you wanted to give a substantial loan to one of your children – for example to help them buy a property – you would have to charge an interest rate based on what the market is asking for for personal loans in order to avoid ‘it does not qualify as a gift for tax purposes.
But you can also use the exemption to offset the interest bill. For example, if you lent your child € 15,000 at a market rate of 10pc, that would result in an annual interest bill of € 1,500 which you could discount using this relief, leaving you with € 1,500 in the exemption for that year.r.