The Certainties of Life – Death and Taxes
Written by Tina Winter
There are only two certainties in life according to Benjamin Franklin. To those we can add the certainty that questions on Inheritance Tax (IHT) will come up if you are sitting J01 or R03 exams.
IHT is the place where death and taxes collide – although according to HMRC statistics only in the region of 3% of estates in any given tax year have to pay the tax. This is largely because the estate value was less than the Nil Rate Band (currently £325,000 and due to stay at that level until at least April 2015), but in other cases it will be the result of good lifetime planning utilising exemptions and reliefs. IHT is due on estates with a value in excess of the nil rate band at the death rate of 40%.
The major tax saver is the inter-spouse exemption. Transfers between UK-domiciled spouses and civil partners, during life and on death, are exempt from IHT. This applies whether or not the spouses are living together but stops on divorce. If the transferor is UK domiciled but the spouse or civil partner is not, the exemption is currently limited to £55,000.
Since October 2007, you can transfer any unused Inheritance Tax threshold from a late spouse or civil partner to the second spouse or civil partner when they die. This can increase the Inheritance Tax threshold of the second partner – from £325,000 to as much as £650,000 in 2012-13, depending on the circumstances. Prior to that date, married couples with joint estates that exceeded twice the nil rate band often set up wills where assets to the value of the nil rate band on first death passed other than to their spouse, often to a trust, but the legislation introduced made planning of that type obsolete.
The transfer must be claimed on the second death, within two years of the end of the month in which death occurs. The relief extends to deaths of the first spouse occurring before October 2007, and the relief is given whether or not the survivor has entered into a new relationship. Unused nil rate band on the first death is calculated as the available nil rate band on the first death (M) minus the nil rate band set against the chargeable transfer on that death (VT). The nil rate band maximum on second death is then increased by the same percentage that M – VT represents of the nil rate band maximum at the first death. This is best illustrated by an example.
Doris died in May 2007, leaving an estate of £300,000. She leaves £120,000 to her three children and the rest of her estate (£180,000) to her husband Boris. When Doris died the Inheritance Tax threshold was £300,000. Boris dies in September 2012, leaving an estate worth £500,000 which he leaves to his children. When Boris died the threshold was £325,000.
The amount of Doris’s threshold that can be transferred to Boris is:
- threshold at the time of the first death (Doris) = £300,000
- minus the legacies to her children who aren’t exempt = £120,000
- leaving a remaining threshold of £180,000
The percentage by which to increase the threshold on the second death (Boris) is:
- the threshold remaining from Doris’s death (£180,000)
- divided by the threshold at the time of Doris’s death (£300,000)
- multiplied by 100 (£180,000 ÷ £300,000 × 100 = 60%)
So the threshold available to transfer to Boris’s estate is £325,000 × 0.6 (60%) = £195,000. This is added to Boris’s own threshold of £325,000, increasing his threshold to £520,000. Because Boris’s estate is lower than this, there’s no Inheritance Tax to pay.