‘Academic’ Intelligence: A (Very) Brief Overview of Tax, Part Three

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Today’s article is the final one on taxation and will endeavour to look into some basic issues surrounding Inheritance Tax (‘IHT’).

The basic rule is that, when a person passes away his estate is taxed at 40% so long as it amounts to more than £ 325, 000. If the value of the estate is below £ 325, 000, or within what is known as the Nil Rate Band (‘NRB’), it is taxed at 0%.

‘Estate’ means (in general terms) everything that the deceased owed at the time of his death.

Let us an example:

John passed away in January 2012. He left a will saying that his Rolex watch and his doughnut business were to go to his son, Dan whilst everything else was to go to his wife, Gemma. At the time of his death, his estate consisted of:

• His VW Passat- £ 2500
• His Don King Doughnuts LTD business valued at £ 300, 000, which he had owned since 2000
• 12 Donald Road, a property he owned with his wife, Gemma, as joint tenants- £ 200, 000
• HSBS Bank account in his sole name- £ 1000
• His Rolex Watch- £ 1000

In February 2003 John made a gift of £ 1000 to his, Dan.

In March 2010, John made a gift of £ 3000 to his daughter, Jodie.

In December 2011, John paid £ 3000 into the Dog Trust.

John’s death estate is made up of his VW, his doughnut business, ½ of the jointly owned property, his HSBC account and his Rolex watch and is, therefore, calculated as follows:

£ 2500 + £ 200, 000 + £ 80, 000 (1/2 of the price of the property – 10% its value for IHT purposes) + £ 1000 + £ 1000= £ 384, 000.

The taxable estate, however, is another matter.

Under the will, Gemma, John’s wife, is to inherit everything but the Rolex and the Doughnut business, id est £ 183, 000. This sum is fully  IHT exempt as the ‘spouse exemption’ applies (s. 18 Inheritance Tax Act 1984 ‘IHTA’).

The doughnut business is covered by the business property relief (‘BPR’), ss. 103- 114 IHTA, as John had owned it for more than two years and was a limited company (unquoted shares).

The Rolex is not covered by any exemptions.

The two transfers that John made to his daughter and his son are called Potentially Exempt Transfers (individual to individual, ‘PET’) and are only taxed at 40% if the donor, i.e. John, does not survive within seven years of the gift.

The gift of £ 1000 to Dan, then, will not be taxed as John has survived the seven years.

The gift of £ 3000 to Jodie will, however, will attract IHT. Taper relief does not apply here because the donor has failed to survive at least free years (for more on taper relief and its application, please see << http://www.hmrc.gov.uk/inheritancetax/how-to-value-estate/gifts.htm#4 >>).

The final transfer of £ 3000 that John did into the dog trust is called a Life- Time Gift (individual into a trust, ‘LCT’).

IHT at 20% is payable at the onset; i.e. John should have paid £ 600 when he initially made the gift. If the donor survives for seven years, no further charge will be applied. Otherwise, IHT will need to be recalculated at 40% and the balance paid to HMRC.

In our case, however, an Annual Exemption of £ 3000 can be applied to the LCT; thus, it will not be included in the taxable estate.

 In the light of the above, then, the John’s taxable estate is made up of the HSBC account and the gift to Jodie, id est £ 4000.

As, however, this falls in the NRB, the IHT is paid at 0% and, thus, no IHT is due.

IHT calculations (much like CGT, CT, etc. ones) are, of course, much more complicated than the above examples and, should you need advice on your tax planning, I suggest you go to a specialist solicitor rather than referring to my articles as they are but a mere overview of various taxes in the UK.