‘Tax doesn’t have to be taxing’ is one of HM Revenue & Customs’ favourite stock phrases, trumpeted during the simplification of income tax returns and periodically revived as a slogan whenever tax legislation undergoes change. In my 17th year of working in Wills and Probate, however, I remain unconvinced that this can be said quite so readily for inheritance tax (IHT). HMRC do not make it easy for families or professionals who are dealing with estates subject to these complex rules.
Here we look at why IHT liabilities can be a taxing affair and the red flags for you, the Adviser, to look out for with your clients when giving advise on their estates – whether this be with their mortgage, investments or life insurance.
Calculating the gross Estate
There will always be a debate to be had about how fair or unfair the present IHT system may be. For families who find themselves having to deal with an estate’s IHT bill however, parity is often the least of their worries. Those named as Executors in someone’s Will are responsible not only for paying IHT, but for establishing how much is due. This can be a lengthy and time-consuming process even where an estate is simple, never mind those occasions where more opaque tax rules such as Agricultural Property Relief (APR) or Business Property Relief (BPR) are involved.
The first step is to ascertain whether or not an estate is taxable (the current threshold is £325,000, with an additional £125,000 of tax relief available if the deceased’s estate qualifies for the residence nil rate band). To do so, the Executor needs to calculate the gross estate value. Executors can deduct all bills to the estate at the date of death, and any funeral expenses, when calculating this amount. Like almost all undertakings relating to IHT, this will require the completion of requisite forms.
In order to calculate the gross estate, the Executor may have to arrange for properties to be valued; they may also have to arrange for professional valuation of expensive chattels such as jewellery or furniture (in managing a recent case I had to arrange for the valuation of a narrowboat!). A detail often missed is that any lifetime gifts made in the last 7 years of the deceased’s life will also need to be included.
Once the Executor has established the extent and value of an estate, the calculation of due IHT can begin. There are various reliefs that can be applied to qualifying estates on top of the deduction of debts and funeral costs described earlier, though in many circumstances legal and/or financial advice will be required to ascertain eligibility (e.g. for business property relief, or BPR). The current rate of IHT is 40%; this charge has to be satisfied within six months of the date of death before the Grant of Probate can be obtained.
This requirement creates something of a catch-22, since many institutions will refuse to release funds until they have sight of the Grant of Probate. If there are insufficient funds to settle an IHT bill, Executors cannot obtain the Grant; yet without the Grant, Executors cannot obtain funds to settle the tax charge in the first place. In many situations, Executors have to settle the tax liabilities themselves and reclaim this from the estate at a later date, or even take out a bank loan in order to cover these charges.
There is also the possibility of arranging for inheritance tax to be paid in instalments; the Grant is then released after the first instalment is settled. Arrangements for these annual payments will need to be made by the Executors, who are also charged with covering these payments. HMRC do not send annual statements of monies paid, so it’s important that Executors keep their accounts up to date.
If the deceased had any life assurance policies in place, then a further option is to use the proceeds from these to settle an outstanding IHT liability. Policies written into trust will not form part of the estate for IHT purposes; however, for this reason, it is important to leave written instructions to ensure that funds from any policy are used as intended.
If IHT is not paid within the allotted 6 month period, HMRC can levy significant penalties. Because obtaining accurate valuations and date of death values can take time, particularly where there are numerous or substantial holdings or unusual assets, many practitioners estimate the tax due and settle this as soon as they have obtained a reference number. Any excess IHT paid can be reclaimed at a later date.
Quite often, then, inheritance tax is a taxing affair. When appointing Executors, it’s vital to ensure that they have the requisite eye for detail, as well as the ability to commit a substantial amount of time to managing the estate’s tax affairs. Looking to family members or even close friends is one option but it is also possible to appoint an experienced professional to handle these matters on one’s behalf, in which case, thankfully, things are as straightforward as the government often likes to suggest.
This is where the clients’ adviser can become better serve their client. Although they don’t need to become directly involved, Advisers are in an excellent position to know the IHT liability of clients. Extending the conversation with clients can ensure that they are better protected and fully aware of the complexities of their estate.
Legal Services Director