IHT Question

[yieldhog]

My questions about Inheritance Tax (IHT) are best illustrated by examples:

A married couple, both aged 75, currently have an estate worth £900,000.
The estate consists of a property worth £500,000, household and personal items worth £100,000 and cash/securities of £300,000
They have one adult son.
They have wills that leave everything to the surviving spouse and when the last of them dies it all goes to the son.
One year ago they set up an irrevocable trust in the name of the son and jointly gifted it with cash of £400,000.

If they both died tomorrow IHT due would be:
40% of (£900,000 + £400,000 - £1,000,000) = £120,000
The full value of the gift would be added to the estate because no taper relief would be available until two years had passed since the £400,000 was given.
If one partner died tomorrow IHT would be:
A. Nil because the deceased’s entire estate would pass to the surviving spouse free of IHT.
B. {50% of (£900,000 +£400,000) - £325,000} x 40% = £130,000 based on the deceased’s value of the estate at the time of death less their personal allowance of £325,000.
C. Neither A or B and if so what would it be and why?
If both survived eight years after the gift was given and, other things being equal, then both died IHT would be:
Nil because the estate is now below the £1,000,000 the joint exemption amount of (£325,000 + £175,000) x 2 and the gift is more than seven years old and hence no longer forms part of the estate.
If one partner dies five years after the gift is given then IHT would be:
A. Nil because the deceased’s estate would pass to the surviving spouse free of IHT
B. Nil IHT is due but Gift Tax on the deceased’s share of the gift is due according to the taper relief scale (16% after 5 – 6 years which would be £32,000). Surviving spouse gets the full £325,000 and £175,000 of the deceased’s IHT allowances.

I’m most interested in the last scenario because it’s the one that’s most likely to impact my own family situation.

[gryffron]

Hi yieldhog,

Ok, I'll have a go at this.

Couples don't have estates and don't pay IHT. Individuals do. All the assets you are considering "theirs" are owned for IHT by one or the other. Or for IHT purposes, 50% each if truly legally "joint". Thinking about it like that makes your problem clearer.
Gifts between spouses are exempt from tax both in life and IHT.
Spouses can leave UNUSED IHT allowances to each other.

So when you say "jointly gifted", was this really the case? HMRC may consider where the gift really came from. If they really paid half each, fine. If they paid from a joint account it will be assumed 50/50. But if one spouse transferred it all, then HMRC may consider that a gift from one individual, even if the couple thought of the money as "ours".
For the sake of your examples I'm going to assume the 50/50 split holds, and there's no change in values or rates over time, as it's more complicated otherwise.

Everyone has a £3k [[edit]annual] gift allowance, which can be carried forward one year.

There is no "gift tax". A gift paid (less gift allowance(s)) immediately becomes a Potentially Exempt Transfer (PET), which may be subject to IHT with taper relief. After 7 years it becomes and Exempt Transfer, and disregarded for IHT.

So in your example, on the basis of what you have told us, each of the couple have made PETs of £200k-£3k-£3k = £194k. On the date the money was paid.

When ONE of the spouses die within 7 years:
The balance of their estate goes to spouse - no IHT.
Everything not paid to spouse is subject to IHT, less personal allowance. In this case £194k < £325k so nothing to pay.
The spouse "inherits" the remaining UNUSED allowances(**) = £325k-£194k = £131k. So the second spouse whenever they die will have IHT allowance of £325k (theirs) + £131k (transfer from spouse) + (2* £175k) (property) = £806k.

When the second spouse dies.
IHT payable on £900k - £806k = £94k at 40%
(Because there's no allowance left) PET taxable of £194k at whatever rate, tapered by the time between gift and death.

Note: There is NO taper on the allowance reduction from a PET, only the tax rate. It is 100% for 7 years, and 0 thereafter.

(**) Even more confusingly, the spouse technically inherits a PERCENTAGE of the unused allowance, not an absolute figure. In this case 131/325=40.3%. So if the numbers change between the 2 deaths, the second spouse would have 140.3% of the personal allowance and 200% of the property allowance at the time of the second death - confused yet!

Gryff

[yieldhog]

Many thanks Gryff. That certainly gives me something to mull over for a few days. If it wasn't confusing enough already I have several additional factors to take into consideration, but I will need to get my head around the information you've kindly provided before adding them into the equation.
Y

[yieldhog]

Gryff,
Having studied your response to my questions I found your answer very clear and easy to understand. I'm going to copy it and keep it with our wills for future reference. I'm sure things will change over time but now I'll have a reference point to see what difference any tax changes or personal changes make to our situation. Thanks again for your excellent post.
Y