Inheritance Tax changes and the Pre-Budget Report

The Chancellor made changes to the Inheritance Tax regime announced in the Government’s Pre-Budget Report on 9 October 2007.  This has left many people confused as to how the changes will affect them.

All individuals can leave up to £300,000 free of Inheritance Tax (known as the Nil Rate Band), but sums above this are taxed at 40%.  The Chancellor appeared to double the Inheritance Tax threshold to £600,000 for married couples and civil partners. However couples had always been able to pass up to £600,000 to their heirs without paying death duties by setting up Nil Rate Band Discretionary Trusts through their Wills and by changing the way that they held their property.

The changes in the law mean that couples will now be able to utilise their joint IHT exemption without making Nil Rate Band Discretionary Trust Wills.  They will be able to transfer their individual allowance, so when the first spouse dies, their share of the home and any other assets can be simply transferred to the surviving spouse. On the death of the second spouse inheritance tax will only be paid if assets exceed £600,000 (twice the current Nil Rate Band).

If you already have a Nil Rate Band Discretionary Trust Will and the only reason for this was to utilise both spouses’ Nil Rate Band then it is pretty obsolete now.  However, there are still some advantages for the surviving spouse to keep their existing Wills.  These Trusts can be particularly useful if you want to ensure that money is passed directly to children or grandchildren, especially if they are from a previous marriage.

The Chancellor has also allowed widows and widowers to benefit by back-dating this change so that they can make use of their deceased spouse’s unused allowance.  The main query is whether it is today’s IHT allowance (of £300,000) that would apply, or the allowance applied in the year that their husband/wife died.  The key date is when the second spouse dies: the prevailing married couples’ allowance at this point applies.  Today this allowance is £600,000, although it will increase in the future.

It must be pointed out that if the deceased’s spouse left assets to children or other heirs, the value of these gifts will be deducted from their allowance.  It is not a straightforward calculation and how much of the Nil Rate Band can be used on the second death is worked out by looking at the proportions of the allowance used on first death.  It will also be the duty of the executors of the second spouse’s estate to show that the Nil Rate Band had not been used on first death.  We advise that as much documentation as possible is retained following first death.

Even if a widow or widower remarries they will still be able to use their deceased spouse’s allowance.  However, the maximum Inheritance Tax allowance available today is £600,000, regardless of how many spouses they have had.  Once you are divorced you are effectively treated as a single person for tax purposes so former wives or husbands will not be able to use their ex-partner’s allowance, even if they are passing assets on to children from that marriage.

If a Discretionary Trust has already been set up following a first death and it is within two years of death, I would suggest that you seek legal advice.

To contact Raworths, telephone 01423 566666 or visit our offices at Eton House, 89 Station Parade, Harrogate HG1 1HF. Or email safter.karim@raworths.co.uk.