The final five important IHT traps and practical points to consider in this issue are:
11. Thinking you are exempt from IHT when living abroad
If intending to retire abroad, beware of tax traps. Even if you have no intention of returning to the UK, the facts of your case may mean that you are deemed domicile and all of your assets worldwide will be subject to UK IHT. To be truly non-domiciled and to escape IHT in the UK, you must sever all obvious ties with the UK. The tax treatment of investments may change if you move abroad. UK tax free or tax deferred income, say from an investment bond or ISA, may be taxable in some countries.
Tip – you may need a second will to deal with assets accumulated whilst living overseas. If you die abroad and intend to be buried in the UK, you could be deemed domiciled in the UK with worldwide assets subject to IHT. This happened to Richard Burton, the actor, who lived in Switzerland and wished to be buried in Wales.
12. Not reducing your estate when you could have
You could have assets that have been protected but are now producing income beyond your needs that are added back to your taxable estate. Strategies would include regularly making gifts out of income (above your normal) expenditure, for example, to grandchildren to help pay their mortgages or school fees.
You may make gifts to individuals and bare trusts (and certain other trusts) that will be within the ‘potentially exempt transfer’ (PET) rules – if you survive for seven years, the value of the gift and any growth on it will be out of your estate. Gifts made to spouses or civil partners are normally exempt and will therefore be immediately be out of your estate. You need to plan well in advance with regard to depleting your estate through donations to others.
Tip – gifts out of income must be regular and from income, not capital. This exemption is unlimited. Document every gift and sources of income. Make gifts of up to £3,000 p.a. (annual exemption); unlimited gifts of up to £250 to any person p.a.; marriage gifts -£5,000 by each parent, £2,500 by each grandparent; gifts to trust to use the IHT nil rate band of £325,000.
13. Making gifts in the wrong order
Getting the order of gift-making wrong can be costly. This assumes that gifts to be made may either be chargeable lifetime transfers (CLT), for example made to a trust, or exempt, such as those made to people under the PET rules.
First, fully exempt gifts should be made, then loans to trusts, then CLTs, and finally PETs. It is important that CLTs are made to discretionary trusts before PETs, as the ten-year periodic charge on the discretionary trust will depend on what other CLTs were made in the seven years before the discretionary trust was established.
If someone who made a PET within the seven-year period died within the seven years, the now failed PET becomes a CLT and will be included in the calculation at the ten-year anniversary for the discretionary trust. If the PET was made after the CLT then, on failing within the seven-year period, it cannot be included in the calculation, thus reducing the tax bill.
Tip - Getting the order wrong could result in higher IHT bills. Getting it right could save a massive amount in IHT. If a gift of £325,000 was made in the 2011/12 tax year to a discretionary trust, and treated as a CLT, followed by the same amount to a bare trust (treated as a PET), then the estate could be reduced by £650,000 without any IHT consequences (subject to the seven year survival period mentioned earlier).
14. Not planning around the business
The business can generate up to 100% IHT business property (BPR) relief. Agricultural property relief (APR) can apply at 50% - 100% on farming businesses and land. However, get it wrong and you could lose your reliefs. There are qualifying rules. After your death, where company shares pass to another, the BPR passes with it.
A director’s loan account in the business does not qualify for BPR on death, (but a partner’s capital account does qualify, unless he or she had already retired at the date of death).
Tip – take the director’s loan account out of the business and invest into an ‘IHT mitigation plan’; the loan account money is replaced with bank finance and the interest on the bank money is tax deductible.
If there are partners or shareholders who want cash for their shares on death, they can insure themselves for their share values under a ‘double option’ agreement and in trust, so that cash is paid for their share of the business at the time when required. This cash is free of IHT.
Tip – do not use a ‘buy and sell agreement’ as the proceeds are inheritance taxable.
15. Wrong advisers
It is most important that you only deal with advisers able and competent to advise you properly and across a broad range of issues. IHT and estate planning encompasses planning around your investments and tax, your business, your house, trusts, wills, your domicile, pensions, generations above and below you, your gifting strategy, potential care home fees, and your personal circumstances and objectives.
Always seek expert professional advice based on your specific personal circumstances. Check out adviser qualifications and expertise and make it known what the planning parameters are going to be.