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Where Taxpayers and Advisers Meet

IHT confusion over estate

BlueDay
Posts:2
Joined:Wed Oct 13, 2021 10:55 am
IHT confusion over estate

Postby BlueDay » Wed Oct 13, 2021 11:37 am

Hi,

I have a question regarding IHT that I would like clarification on. After speaking recently to a finance advisor I am still left a little confused with regards to tax free limits, 7 year rules etc. so I have put together a little hypothetical scenario which someone may be able to clarify for me?


Lets assume that the total estate of two parents is £2.5m. £2.2m of the estate is in cash / savings etc. and their house has a value of £300k.

The parents decide to make a cash gift of £500k to each of their two sons (£1m total) which reduces the estate value to £1.5m.

One parent dies and the second parent survives for over 5 years but dies on year 6 after gift has been made.

In this situation my understanding is that the total amount of IHT would be calculated as follows:

The tax free allowance for IHT purposes is currently £325k per parent (£650k for both parents) + £175k per person for the house (£350k for both parents).

This gives a total IHT free allowance of £1m so IHT would only be due on the balance of the estate which is 1.5m (including the cash gift of £1m paid to their sons?).

So now the IHT liability would be calculated as follows:

As the surviving parent dies after 5 years of making the original gift, the IHT tax band for years 5-6 is currently 16% and so this would apply to the original gift of £1m made to the sons which equates to £160k. The balance of the estate would be £500k and would be taxable at the rate of 40% which equates to £200k.

Therefore the total IHT liability for the estate of £2.5m in this instance is £360k.

So of the total £1.5m taxable benefit (estate value of £2.5m - £1m tax free allowance) each son would essentially lose £180k of their £1.25m inheritance (£2.5m estate / 2).

Is this correct or am I over complicating things?


In another scenario, if the parents estate was worth say £950k to start with and they gift their sons a cash amount prior to their death, am I right in saying that no IHT would be due at all as the tax free allowance is £1m?

Any comments welcome!

AGoodman
Posts:1308
Joined:Fri May 16, 2014 3:47 pm

Re: IHT confusion over estate

Postby AGoodman » Wed Oct 13, 2021 7:52 pm

You're way off I'm afraid - partly because you've simplified it too far.

First death (within 3 years): IHT on half the gift of £500,000-£325,000 * 40% = £70k

Second death:

IHT on half the gift = £500,000-£325,000 * 16% = £28k
IHT on the estate = £1,500,000 - £300,000 * 40% = £480,000

Total IHT is £578,000.

Don't forget that you can only claim the additional nil rate band on the value of qualifying property passing to descendants. If the house is only worth £300k, then that is the maximum that can be claimed. The above also assumes that the gift is made jointly by the two parents - i.e. £500,000 each and that the parents leave their estates to each other.

If these sums are realistic, the parents need proper paid advice from somebody (I'd suggest a solicitor or accountant) with expertise in estate planning.

BlueDay
Posts:2
Joined:Wed Oct 13, 2021 10:55 am

Re: IHT confusion over estate

Postby BlueDay » Tue Oct 26, 2021 1:22 pm

OK thanks for your reply. So lets just give this a different slant if I may? Lets say that parent 1 passes their £500k part of the gift to parent 2 and then parent 2 makes the entire gift of £1m to the sons and then dies after 5 years whilst parent 1 dies in less than 3 years.

First death (within 3 years): No gift made to sons so no IHT due.

Second death:

IHT on the gift = £1,000,000 - £650,000 (including spousal transfer) * 16% = £56k
IHT on the death estate = £1,500,000 - £300,000 (main residence nil rate band) * 40% = £480,000

Total IHT is £536,000.


If we were to take a different look at this estate and say that the parents decide give away a total of £1.8m of their £2.5m estate in cash as equal gifts to the sons. This gift is paid by parent 2 and survives for over 7 years after gifting the cash. Parent 1 dies in under 3 years.

First death (within 3 years): No gift made to sons so no IHT due.

Second death:

IHT on the gift = £1,800,000 * 0% (rate band after 7 years) = £0
IHT on the death estate = £400,000 - £300,000 (main residence nil rate band) * 40% = £40,000

Total IHT is £40,000.

If the above calculations are true then it make a lot of sense for the parents to gift as much of the estate as they can and as early on as possible so that the sons have massively reduced IHT liabilities. That's if my sums are correct of course!

AGoodman
Posts:1308
Joined:Fri May 16, 2014 3:47 pm

Re: IHT confusion over estate

Postby AGoodman » Thu Oct 28, 2021 2:37 pm

Your second example is an overestimate as the total nil rate bands available on the second death would be £1m - therefore no IHT.

The practical difficulty with solutions involving gifts of most of the estate (apart from the donor having to live for 7 years) is that the parents shouldn't give away funds/assets they need to live or might need if they require long term care.


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