New Review Recommends Changes to Inheritance Tax

Inheritance tax actually applies to less than 5% of annual deaths, but it is the most hated tax for Britons. The Office of Tax Simplification (or OTS) has made recommendations for the future of inheritance tax following a review on how it could be simplified. Most taxes can be complicated and difficult to understand, so the Treasury may decide to implement these changes to make Inheritance Tax more straightforward. Read on to learn about the suggested changes and how they could affect you in the future.

What is Inheritance Tax?

When somebody passes away, they usually leave behind an estate. This is the money, possessions, and property that they accumulated before they died. Depending on the total value of the estate, the inheritor may have to pay Inheritance Tax on it. If the estate goes to a living spouse or charity, or if it is worth less than £325,000, then Inheritance Tax will not apply. If the tax does apply, it will be 40% of the amount above £325,000. If the person chooses to gift part of their estate to someone while they are still alive, then Inheritance Tax may apply retroactively when they die. However, taper relief according to the length of time between the gift-giving and the giver’s death will determine the percentage that the recipient has to pay. The major changes suggested by OTS would affect how much a person can give and how long they must be alive for after.

Shortening 7-Year Gifting Rule to 5 Years

Currently, gifts of financial value are liable for Inheritance Tax if they were given within 7 years of the person dying. The OTS suggests that the government should reduce this to 5 years instead. It will only apply in any case if the person with the estate had given away a total value of at least £325,000 in the 7 years before their death. The taper relief means that the amount of tax depends on the length of time between the giving of the gift and the giver dying. The OTS suggests doing away with taper relief, too. However, this would create a steep “cliff-edge” at the 5-year mark. If the person dies 4 years and 364 days after giving the gift, then the recipient would be liable for the tax. If the recipient cannot pay, the executor of the estate becomes responsible. The reasoning for reducing it to 5 years is that most bank statements are only available for 6 years.

Setting a Single Personal Gift Allowance

The inheritance tax exemptions for gift-giving come in a confusing array. The OTS suggests changing this by creating just one overall allowance. Each person would have a fixed amount that they could give away each year without the gift being liable for inheritance tax. They didn’t suggest an amount for this allowance, just that it should be sensible. Anyone can give away up to £3,000 in gifts per year (only up to £250 per individual) according to the current rules. There are even more allowances for gifts towards things like living costs and weddings as well. However, if the allowance had risen with inflation since it was set back in the 1980s, the annual allowance would now equal £11,900. There is also an issue with gifts out of income as exemptions. There is no fixed definition of which gifts count for this, so the OTS thinks that the government should set either a fixed percentage of income or a single personal gift allowance.

Clarifying the Capital Gains Tax Uplift

Whenever someone inherits assets from somebody upon their death, a capital gains uplift will apply. This means that the person will inherit the asset at its current market value at the time of the owner’s death, rather than its original value at the time of purchase or acquirement. Since the 1970s, the government does not charge Capital Gains Tax on inherited assets after death. This is because they assume that Inheritance Tax will apply instead. However, this is not always the case. Some estates end up having to pay both Inheritance Tax and Capital Gains Tax, while some estates will be liable for neither. This is not particularly fair and affects people’s decisions about passing on assets while they are still alive. The OTS recommends clearing this issue up by removing the capital gains tax uplift altogether. The downside is that this is likely to lead to higher CGT bills, which will affect divestment plans for individuals and businesses.

What are the experts saying about these recommendations?

Experts on tax are commenting on the proposals from the OTS with some concern. The OTS chairperson Kathryn Cearns (OBE) said that the recommendations from the review would make inheritance tax easier for people to understand and comply with. Sue Moore of the Institute of Chartered Accountants in England and Wales said that reducing the gifting period to 5 years would benefit more people overall, even with the removal of taper relief. James Ward of Kingsley Napley LLP law firm agreed that it was overall a good suggestion, but warned that it would negatively affect wealthier clients with more substantial assets to gift. Both experts agreed that combining gift allowances into one is sensible, but the abolition of gifting excess income in favour of a single personal allowance is contentious. James Ward specified that such changes to Inheritance Tax would hinder inter-generational gifting, which younger generations are often dependent on. The government needs to consult on possible changes to the tax before they become law, which could take some time. They may not decide to act upon the suggestions of the OTS.