Tagged: IHT

A gift with reservation

Posted on August 17, 2009 by - All News, Financial News

Making sure the gift is not a gift for Inheritance Tax purposes

A gift with reservation is a gift which is not fully given away. Where gifts with reservation were made on or after 18 March 1986, you can include the assets as part of your estate but there is no 7 year limit as there is for outright gifts. A gift may begin as a gift with reservation but some time later the reservation may cease.

In order for a gift to be effective for exemption from Inheritance Tax, the person receiving the gift must get the full benefit of the gift to the total exclusion of the donor. Otherwise, the gift is not a gift for Inheritance Tax purposes.

For example, if you give your house to your child but continue to live there rent free, that would be a gift with reservation. If after 2 years you start to pay a market rent for living in the house, the reservation ceases when you first pay the rent. The gift then becomes an outright gift at that point and the 7 year period runs from the date the reservation ceased. Or a gift may start as an outright gift and then become a gift with reservation.

Alternatively, if you give your house to your child and continue to live there but pay full market rent, there is no reservation. If over time you stop paying rent or the rent does not increase, so it is no longer market rent, a reservation will occur at the time the rent stops or ceases to be market rent.

The value of a gift for Inheritance Tax is the amount of the loss to your estate. If you make a cash gift, the loss is the same value as the gift. But this is not the case with all gifts.

Important exemptions

Posted on August 17, 2009 by - All News

Legally passing your estate without it being subject to Inheritance Tax

There are some important exemptions that allow you to legally pass your estate on to others, both before and after your death, without its being subject to Inheritance Tax.

Exempt beneficiaries

You can give things away to certain people and organisations without having to pay any Inheritance Tax. These gifts, which are exempt whether you make them during your lifetime or in your will, include gifts to:

your husband, wife or civil partner, even if you’re legally separated (but not if you’ve divorced or the civil partnership has dissolved), as long as you both have a permanent home in the UK
UK charities

some national institutions, including national museums, universities and the National Trust
UK political parties

But, bear in mind that gifts to your unmarried partner or a partner with whom you’ve not formed a civil partnership aren’t exempt.

Exempt gifts

Some gifts are exempt from Inheritance Tax because of the type of gift or the reason for making it. These include:
Wedding gifts/civil partnership ceremony gifts

Wedding or civil partnership ceremony gifts (to either of the couple) are exempt from Inheritance Tax up to certain amounts:

parents can each give £5,000

grandparents and other relatives can each give £2,500
anyone else can give £1,000

You have to make the gift on or shortly before the date of the wedding or civil partnership ceremony. If it is called off and you still make the gift, this exemption won’t apply.

Small gifts

You can make small gifts, up to the value of £250, to as many people as you like in any one tax year (6 April to the following 5 April) without them being liable for Inheritance Tax.

But you can’t give a larger sum: £500, for example, and claim exemption for the first £250. And you can’t use this exemption with any other exemption when giving to the same person. In other words, you can’t combine a ‘small gifts exemption’ with a ‘wedding/civil partnership ceremony gift exemption’ and give one of your children £5,250 when they get married or form a civil partnership.

Annual exemption

You can give away £3,000 in each tax year without paying Inheritance Tax. You can carry forward all or any part of the £3,000 exemption you don’t use to the next year but no further. This means you could give away up to £6,000 in any one year if you hadn’t used any of your exemption from the year before.

You can’t use your ‘annual exemption’ and your ‘small gifts exemption’ together to give someone £3,250. But you can use your ‘annual exemption’ with any other exemption, such as the ‘wedding/civil partnership ceremony gift exemption.’ So, if one of your children marries or forms a civil partnership you can give them £5,000 under the wedding/civil partnership gift exemption and £3,000 under the annual exemption, a total of £8,000.

Gifts that are part of your normal expenditure

Any gifts you make out of your after-tax income (but not your capital) are exempt from Inheritance Tax if they’re part of your regular expenditure.

This includes:

monthly or other regular payments to someone, including gifts for Christmas, birthdays or wedding/civil partnership anniversaries

regular premiums on a life insurance policy (for you or someone else)

It’s a good idea to keep a record of your after-tax income and your normal expenditure, including gifts you make regularly. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.

Maintenance gifts

You can also make Inheritance Tax-free maintenance payments to:

– your husband or wife
– your ex-spouse or former civil partner
– relatives who are dependent on you because of old age or infirmity
– your children (including adopted children and step-children) who are under 18 or in full-time education

Potentially exempt transfers’
If you, as an individual, make a gift and it isn’t covered by an exemption, it is known as a ‘potentially exempt transfer’ (PET). A PET is only free of Inheritance Tax if you live for 7 years after you make the gift.

Gifts that count as a PET are gifts that you, as an individual, make to:

another individual

a trust for someone who is disabled

a bereaved minor’s trust where, as the beneficiary of an Interest In Possession (IIP) trust (with an immediate entitlement following the death of the person who set up the trust), you decide to give up the right to receive anything from that trust or that right comes to an end for any other reason during your lifetime

Only ‘outright gifts’ count as PETs
If you make a gift with strings attached (technically known as a ‘gift with reservation of benefit’), it will still count as part of your estate, no matter how long you live after making it. For example, if you give your house to your children and carry on living there without paying them a full commercial rent, the value of your house will still be liable for Inheritance Tax.

In some circumstances a gift with strings attached might give rise to an Income Tax charge on the donor based on the value of the benefit they retain. In this case the donor can choose whether to pay the Income Tax or have the gift treated as a gift with reservation.

Minimising an Inheritance Tax liability

Posted on August 17, 2009 by - All News

Passing assets to beneficiaries using a trust

You may decide to use a trust to pass assets to beneficiaries, particularly those who aren’t immediately able to look after their own affairs. If you do use a trust to give something away this removes it from your estate, provided you don’t use it or get any benefit from it. But, bear in mind that gifts into trust may be liable to Inheritance Tax.

Trusts offer a means of holding and managing money or property for people who may not be ready or able to manage it for themselves. Used in conjunction with a will, they can also help ensure that your assets are passed on in accordance with your wishes after you die.

When writing a will, there are several kinds of trust that can be used to help minimise an Inheritance Tax liability. On 22 March 2006 the government changed some of the rules regarding trusts and introduced some transitional rules for trusts set up before this date.

A trust might be created in various circumstances, for example:

– when someone’s too young to handle their affairs
– when someone can’t handle their affairs because they’re incapacitated
– to pass on money or property while you’re still alive
– under the terms of a will
– when someone dies without leaving a will (England and Wales only)

What is a trust?
A trust is an obligation binding a person called a trustee to deal with property in a particular way for the benefit of one or more ‘beneficiaries.’

Settlor
The settlor creates the trust and puts property into it at the start, often adding more later. The settlor says in the trust deed how the trust’s property and income should be used.

Trustee
Trustees are the ‘legal owners’ of the trust property and must deal with it in the way set out in the trust deed. They also administer the trust. There can be one or more trustees.

Beneficiary
This is anyone who benefits from the property held in the trust. The trust deed may name the beneficiaries individually or define a class of beneficiary, such as the settlor’s family.

Trust property
This is the property (or ‘capital’) that is put into the trust by the settlor. It can be anything, including:

land or buildings
investments
money
antiques or other valuable propertyThe main types of private UK trust:

Bare trust

In a bare trust the property is held in the trustee’s name but the beneficiary can take actual possession of both the income and trust property whenever they want. The beneficiaries are named and cannot be changed.

You can gift assets to a child via a bare trust while you are alive, which will be treated as a Potentially Exempt Transfer (PET) until the child reaches age 18, (the age of majority in England and Wales), when the child can legally demand his or her share of the trust fund from the trustees.

All income arising within a bare trust in excess of £100 per annum will be treated as belonging to the parents (assuming that the gift was made by the parents). But providing the settlor survives 7 years from the date of placing the assets in the trust, the assets can pass Inheritance Tax free to a child at age 18.

Life interest or interest in possession trust

In an interest in possession trust the beneficiary has a legal right to all the trust’s income (after tax and expenses), but not to the property of the trust.

These trusts are typically used to leave income arising from a trust to a second surviving spouse for the rest of their life. On their death, the trust property reverts to other beneficiaries, (known as the remaindermen), who are often the children from the first marriage.

You can, for example, set up an interest in possession trust in your will. You might then leave the income from the trust property to your spouse for life and the trust property itself to your children when your spouse dies.

With a life interest trust, the trustees often have a ‘power of appointment’ which means they can appoint capital to the beneficiaries, (who can be from within a widely defined class, such as the settlor’s extended family), when they see fit.

Where an interest in possession trust was in existence before 22 March 2006, the underlying capital is treated as belonging to the beneficiary or beneficiaries for Inheritance Tax purposes, for example, it has to be included as part of their estate.

Transfers into interest in possession trusts, after,
22 March 2006 are taxable as follows:

20 per cent tax payable based on the amount gifted into the trust at the outset, which is in excess of the prevailing nil rate band;

10 years after the trust was created, and on each subsequent 10 year anniversary, a periodic charge, currently 6 per cent, applied to the portion of the trust assets, which is in excess of the prevailing nil rate band.

The value of the available ‘nil rate band’ on each 10 year anniversary may be reduced, for instance, by the initial amount of any new gifts put into the trust within 7 years of its creation.

There is also an exit charge on any distribution of trust assets between each 10 year anniversary.

Discretionary trust

The trustees of a discretionary trust decide how much income or capital, if any, to pay to each of the beneficiaries but none has an automatic right to either. The trust can have a widely defined class of beneficiaries, typically the settlor’s extended family.
Discretionary trusts are a useful way to pass on property while the settlor is still alive and allows the settlor to keep some control over it through the terms of the trust deed.

Discretionary trusts are often used to gift assets to grandchildren, as the flexible nature of these trusts allows the settlor to wait and see how they turn out before making outright gifts.

Discretionary trusts also allow for changes in circumstances, such as divorce, re-marriage and the arrival of children and step children after the establishment of the trust.

When any discretionary trust is wound up, an exit charge is payable of up to 6 per cent of the value of the remaining assets in the trust, subject to the reliefs for business and agricultural property.

Accumulation and maintenance trust

An accumulation and maintenance trust is used to provide money to look after children during the age of minority. Any income that isn’t spent is added to the trust property, all of which later passes to the children.

In England and Wales the beneficiaries become entitled to the trust property when they reach the age of 18. At that point the trust turns into an ‘interest in possession’ trust. The position is different in Scotland, as, once a beneficiary reaches the age of 16, they could require the trustees to hand over the trust property.

Accumulation and maintenance trusts which were already established before 22 March 2006, and where the child is not entitled to access the trust property until an age up to 25, could be liable to an Inheritance Tax charge of up to 4.2 per cent of the value of the trust assets.

It has not been possible to create accumulation and maintenance trusts since 22 March 2006, for Inheritance Tax purposes. Instead, they are taxed for Inheritance Tax as discretionary trusts.

Mixed trust

A mixed trust may come about when one beneficiary of an accumulation and maintenance trust reaches 18 and others are still minors. Part of the trust then becomes an interest in possession trust.

Trusts for vulnerable persons

These are special trusts, often discretionary trusts, arranged for a beneficiary who is mentally or physically disabled. They do not suffer from the Inheritance Tax rules applicable to standard discretionary trusts and can be used without affecting entitlement to state benefits, however strict rules apply.

Tax on income from UK trusts

Trusts are taxed as entities in their own right. The beneficiaries pay tax separately on income they receive from the trust at their usual tax rates, after allowances.

Taxation of property settled on trusts

How a particular type of trust is charged to tax will depend upon the nature of that trust and how it falls within the taxing legislation. For example a charge to Inheritance Tax may arise when putting property into some trusts, and on other chargeable occasions for instance when further property is added to the trust, on distributions of capital from the trust, or on the 10 yearly anniversary of the trust.

Alternative Investment Market shares

Posted on August 17, 2009 by - All News, Financial News

Reducing an Inheritance Tax liability on an estate

Investing in Alternative Investment Market (AIM) shares is one way of reducing an Inheritance Tax liability on an estate. Qualifying AIM shares offer more Inheritance Tax relief than some other assets and qualify as ‘business property investments.’ If property is held as AIM shares in certain trading companies, for a period of at least 2 years, it becomes eligible for Inheritance Tax Business Property Relief at 100 per cent and will fall out of the estate for Inheritance Tax purposes. This relief is a relief by value, the shares are treated as having no value for Inheritance Tax purposes.

Not all AIM companies are eligible for Business Property Relief however. To qualify, a company must be a trading company carrying out the majority of its business in the UK. Businesses trading in land or securities, or receiving a substantial amount of income from letting property or land, are excluded. Also, it must not be listed on another recognised stock exchange. If a company qualified for Inheritance Tax relief when the shares were bought, but was subsequently disqualified under these criteria, investors must reinvest their holdings into new qualifying shares within 6 months to retain the Business Property Relief exemption.

Investing in the AIM will suit financially secure people with other liquid capital who can invest widely enough to bear the risks involved. AIM shares can be unpredictable and invest in smaller, less established companies with fewer investors than other stock markets, so share prices can be volatile, rising or falling rapidly. You should always receive professional advice before considering this option to mitigate a potential Inheritance Tax liability.