Inheritance Tax may not be at the forefront of most Business Owner's minds but with some fairly straightforward tax planning you could make significant savings. Rawlison Butler LLP's Tax, Trust and Probate Team explains how.
Many people will be aware that when they die, Inheritance Tax (IHT) may well be payable by their families. An individual has a personal allowance for IHT where no tax is payable (called a Nil Rate Allowance). This Nil Rate Allowance is £325,000 for deaths after 6th April 2009. Additionally, any gifts to a surviving spouse or registered Civil Partner will be exempt from IHT. Any assets in excess of the personal allowance which are not exempt from IHT are taxed at 40%.
The general law states that where one spouse dies, leaving the whole of their estate to the survivor of them, then upon the death of that first spouse there is no IHT to pay due to spouse exemption. Upon the death of the second spouse, a 100% uplift in the available IHT Nil Rate Allowance as at the date of the death of the second of them can be claimed, effectively doubling the IHT allowance of the second to die.
For example, if the first spouse dies this year when the IHT threshold is £325,000 and leaves their entire estate to their surviving spouse, who dies in 5 years time when the IHT threshold is, for argument sake, £450,000, then upon that second death the family can effectively claim a double allowance of £900,000 before IHT will start to become payable.
Many business owners are also aware that, as a general rule, their interest in their trading business will be exempt from IHT when they die, so long as the business has been in existence for at least 2 years. Careful thought and planning can open up good IHT planning opportunities.
Typically, unless the family is going to continue to run the business, when a business owner dies, one of two things is likely to happen.
(a) the business may be sold as a going concern; or
(b) other partners/directors in the business may have some form of cross-option agreement and key-man insurance policies which will provide a cash lump sum enabling them to buy out the deceased’s share in the business.
If the business owner intends that his children should benefit from those business assets, and does not intend to pass any benefit from them to his or her spouse, then these assets should be passed to the children now upon his death, with the remainder of the estate passing to the surviving spouse. The business assets are exempt, and as such the full Nil Rate Allowance is unused, and the full 100% transferable nil rate allowance will be available on the death of the second spouse.
However, if the business owner wishes to benefit the surviving spouse completely, and leaves his entire estate to that surviving spouse, the Business Property Relief is likely to be lost. In due course, in the hands of the surviving spouse, these assets are likely to be turned into cash as set out above. When the surviving spouse dies, that cash no longer benefits from the Business Property Relief, and is part of the estate subject to full IHT.
For example, a businessman has a £500,000 share in his business, and private assets with his wife totalling say £500,000 (including the value of the house)
When he dies, his business assets are exempt from IHT under the Business Property Relief rules. His half share of the estate passing to his wife is exempt under the spouse exemption rules – there is no IHT to pay on his death.
However, his business interest is turned into cash after his death and the net proceeds are paid to his wife. When she dies she is now worth £1,000,000. The family will be entitled to claim a 100% increase in her nil rate threshold (having received her husband’s entire taxable estate) allowing £650,000 of her estate to be tax free. However, the remaining £350,000 is subject to IHT at 40%, a total tax bill of over £140,000.
However, it is possible to reduce that IHT bill still further. The use of a discretionary trust as a vehicle into which the business assets are placed after death is the way forward. A discretionary trust is a separate legal entity for IHT purposes, and whilst the surviving spouse would not have an absolute right to the benefit of the monies in that trust, she would potentially be able to benefit from it.
Taking the above example, the savings can be significant:
When the businessman dies, his business interests pass into a discretionary trust. As such it is simply his share of his personal wealth that passes absolutely to his spouse. Again, there is no IHT payable on his death.
However, when the business assets are now turned into cash, they do not belong outright to the surviving spouse, but instead are part of the discretionary trust. When the surviving spouse dies, the only assets in her name are the £500,000 that they owned between them. After deducting the increased personal allowance, the entirety of spouse’s estate is now below the increased IHT threshold of £650,000 and there is therefore no IHT to pay at all. The cash from the business assets is within the trust and not subject to IHT on the survivor’s death.
The trust retains an IHT allowance, so it is only distributions out from the trust in excess of that threshold (£325,000) that are subject to IHT at a maximum rate of 6%, and often a much lower rate. The trust is also subject to IHT at a maximum of 6% every 10 years, but again that is on the excess over the tax threshold.
The savings are potentially very significant, and every business owner should carefully consider their wills and the distribution of their business assets.
For more information on this or any other similar issue, please contact Digby Armstrong by emailing Digby or by calling him on 08450 990045, or speak to your usual contact in the Tax, Trust and Probate Team
This document is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action as a result of the contents of this document.