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The inheritance tax is already the most hated tax in Britain, but it could soon have an even nastier impact as the Chancellor has hinted she will give it a new pair of fangs next Wednesday.
Inheritance taxes will undergo radical changes on October 30, as Rachel Reeves turns to inheritances to help boost the Treasury coffers by £40bn.
An increasing number of grieving families are being forced to pay inheritance tax, and the size of the bills could skyrocket as Mrs Reeves sets out to raise even more money from our inheritances.
Labor ruled out tax rises for ‘workers’ such as VAT, income tax and employees’ National Insurance as part of its election manifesto, so it is left to shore up finances by raiding other tax funds.
Rules: You can make regular gifts from your income without having to pay inheritance tax, as long as it does not affect your standard of living.
Families have already paid £4.3bn in IHT between April and September this year, £400m more compared to the same period last year, official figures published yesterday revealed. But that could just be the start if the Chancellor targets IHT in the Budget.
Here, Money Mail, with the help of tax experts, looks at possible ways Ms Reeves could raid your inheritance and what you can do to protect your savings.
Threat to the zero rate band
At the moment, you can pass on up to £325,000 after your death free of inheritance tax, and married or civil partnership couples can pass on £650,000.
Those who leave property to a direct descendant get an additional allowance of £175,000 each, meaning £500,000 is tax-free.
Therefore, a married couple can pass on a family home worth up to £1 million free of inheritance tax. Anything above this subsidy is taxed at a flat rate of 40 percent.
One of the simplest ways to increase taxes would be to cut this allowance, which is known as the nil rate band.
Huw Witty, corporate tax partner at law firm Shakespeare Martineau, says: “We are likely to see the nil rate band reduced, decreasing the amount at which inheritance tax must be paid.”
The zero rate band has been frozen since 2009 and will remain unchanged until at least April 2028. The Chancellor could extend the freeze further, to 2029 or beyond.
Simply leaving it frozen results in an increasing number of middle-class families being drawn into its web as home and asset values rise while the threshold remains still. Around 4 per cent of deaths now result in an IHT bill.
Bills if you die within ten years.
Currently, gifts you give during your lifetime are free of IHT as long as you survive seven years after giving them.
Die within seven years and they count towards your tax-free allowance of £325,000.
One option Ms Reeves could take is to extend the seven-year rule to ten years. That would mean you would need to survive an additional three years for any donation to be outside your estate for tax purposes.
Rachael Griffin, of wealth manager Quilter, says: ‘This extension would increase the likelihood of the gift being taxable.
Squeeze: An increasing number of families are being forced to pay inheritance taxes, and the size of the bills could skyrocket as Reeves sets out to extract more money from our estates.
For example, for someone who survives eight years after making a lifetime gift of £100,000, the value of the gift would reduce the individual’s inheritance tax relief to £225,000.
‘Without the reform, this donation would have been left out of your assets. Therefore, a much larger proportion of the rest of the estate would be subject to
IHT at 40 per cent, which is a significant tax bill.’
Experts warn that this would create serious administrative challenges for families, who would have to keep a paper trail for longer and prove exactly when the gifts were made.
Andrew Marr, managing partner at tax specialist Forbes Dawson, says: “It’s a nightmare to get all the details of the seven-year rule. A ten-year government will be worse.
Marr fears any extension will need to be implemented immediately so the Treasury can see an immediate tax rise.
And there are fears that the change could even be applied retrospectively. It would mean that people who have already given gifts to loved ones in the hope of not having to pay taxes if they survive seven years would have to live even longer for that same gift to be tax-free.
“If someone donated £2m in October 2017, they are currently out of sight of IHT on that money,” he says. ‘Will that person now have to live another three years?’
The estate of anyone who has died in recent months is unlikely to be affected by any rule changes.
Tapered relief can be discarded
At the moment, IHT gifts are only completely free if you live for seven years. But thanks to gradual relief rules, if you die between three and seven years of making donations, the full 40 percent is waived.
Donations made above your nil rate band within three or four years of your death are charged 32 per cent.
Pass it on: There is currently no limit to the number of gifts you can give in your lifetime, as long as you survive seven years, but this could soon change.
Donations made four or five years ago face a 24 per cent charge, while those made between five and six years before your death have a 16 per cent IHT rate. Those granted six or seven years ago pay 8 percent.
Charlene Young, pensions expert at stockbroker AJ Bell, says: “Eliminating the taper would be a way for the Chancellor to raise more income, but it would create another terrible cliff in our tax system.”
It suggests the tapering rules could be changed alongside the extension of the seven-year rule.
“Any changes to IHT in this area are more likely to involve an extension of the seven-year rule – perhaps to ten years in total – with an extension of the point at which tapering begins, although we don’t yet know how.” That would work,’ he says.
For example, if someone had used their £325,000 allowance and other relief, but had made a gift of £100,000 six years before they died, the estate would currently be liable for an inheritance tax bill of £8,000 for that donation.
But if the phaseout were delayed by three years, it would mean tax would be paid at a rate of 32 percent on the entire sum, rather than a rate of 8 percent. In this case, the taxman would collect £32,000 for the donation, according to Ms Young.
It is more difficult to leave property in a will
People who leave property to a direct descendant get an extra £175,000 of tax relief on their estate, meaning £500,000 is tax-free.
Therefore, a married or civil partnership couple can pass on a family home worth up to £1 million free of inheritance tax, as long as it is worth less than £2 million.
Likely target: One of the simplest ways to raise taxes would be to cut the subsidy given to those who leave property to a direct descendant.
This special allowance is known as the residency nil rate band and was announced by former chancellor George Osborne in 2015.
Marr says this allocation is “an obvious choice” given that most people sell the homes they inherit rather than live in them.
Subsidy every year for gifts
There is currently no limit to the number of donations you can make in your lifetime, as long as you survive seven years.
But Jordan Gillies, partner at wealth management firm Saltus, says the Chancellor could consider an annual allocation for lifetime gifts.
She points to a 2020 all-party parliamentary group report from which she could draw inspiration.
This suggested an annual limit of £30,000 for donations, and anything above this threshold would be taxed at 10 per cent.
The report also suggested that a flat 10 per cent fee should be charged on the estate in the event of death, instead of the current 40 per cent.
He argues that a lower rate with less relief would lead to less evasion and therefore benefit the Treasury.
Households would be less incentivized to plan around complex and punitive inheritance taxes.
But the annual lifetime allowance could have disastrous consequences for parents who gift their children a lump sum as a housing deposit, says Gillies.
“If the Government implements this reform, it would be expected that the inheritance tax would also fall from 40 percent to 10 percent, but the impact on housing would have to be taken into account.”
Great pressure on regular payments
You can make regular gifts from your income without having to pay inheritance tax, as long as it does not affect your standard of living.
Payments can be made from a salary, savings interest or pensions and there is no limit to the amount that can be donated. The seven-year rule does not apply.
Sean McCann, financial planner at insurance firm NFU Mutual, says this rule is one of the most advantageous tax planning tools for the wealthy. He says: “Many NFU Mutual customers use it to pay their grandchildren’s school fees.”
A 2019 report from the now-obsolete Office of Tax Simplification stated that the exemption was too complex.
It recommended that the rule be removed and replaced with a higher personal allowance for the introduction of gifts.
At the moment, you can donate £3,000 each year tax-free, plus as many £250 gifts to as many people as you like. There are also subsidies for gifts made on a couple’s wedding day.
l.evans@dailymail.co.uk
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