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We act for an elderly widow who is the life tenant of a trust established in her late husband's will. He was her second husband and after her death the assets comprised in the will trust will pass to his children by a previous marriage.
Our client has already made potentially exempt transfers from her own assets and is considering making further substantial gifts.
We act for an elderly widow who is the life tenant of a trust established in her late husband's will. He was her second husband and after her death the assets comprised in the will trust will pass to his children by a previous marriage.
Our client has already made potentially exempt transfers from her own assets and is considering making further substantial gifts.
It appears that by making further gifts (and assuming she does not survive the seven-year period), the inheritance tax paid on her assets on death will decrease but that payable by the will trust will increase. This is caused by the fact that the nil rate band is first set against failed potentially exempt transfers before calculating inheritance tax which is then shared between our client's estate and the will trust proportionately, based on the assets actually passing at death (i.e. excluding failed potentially exempt transfers).
Is this correct? If it is, then (subject to available assets) it would seem to be a planning point that potentially exempt transfers, even up to the limit of the nil rate band, should be on the seven-year clock in cases such as this where our client has no particular wish to benefit the remaindermen in the will trust.
(Query T16,074) - Up the Wall.
This is one of those little quirks that could allow the surviving widow to 'punish' an unpopular relative. 'Up the Wall' is correct that the inheritance tax nil rate is first abated against potentially exempt transfers and other lifetime transfers of the deceased and only any balance then set against the taxable estate at death.
We are not told the respective values of the estates, but the two following examples illustrate the effect of lifetime gifts.
If the widow's estate was £1,000,000 and the trust fund £500,000 then, assuming the current full nil rate band were available, there would be a taxable estate of £1,250,000 with tax of £500,000 of which one third would be payable by the trust.
Conversely, if the widow gave away £250,000 in a series of gifts before her death, the value of her own estate would fall to £750,000 (£1,000,000 less £250,000), but the taxable estate would remain at £1,250,000 and the tax would remain unchanged at £500,000, but the proportion payable by the trust would increase to 40 per cent.
Thus, if no gifts were made, the trust pays £166,666; but if the widow makes gifts equivalent to the nil rate then the trust pays £200,000 - a difference of £33,334. However, this is achieved by the widow depriving herself of assets of £250,000 - surely a case of the 'tax tail' wagging with vengeance.
Slightly different results are achieved depending upon whether the trust's or the widow's assets are eligible for agricultural property relief or business property relief, but overall the result will be similar. 'Up the Wall' and his client must consider whether the loss of income on assets given away is worth the marginal advantage that is achieved by such gifts. - Rookery.
'Up the Wall' is quite correct that the inheritance tax nil rate band is applied rateably to the value of the free estate and any settled property in which the deceased had a life interest. This is so the fiction created by section 49(1), Inheritance Tax Act 1984, that the deceased is treated as owning property in which she was entitled only to a life interest, is preserved when calculating the tax.
Correspondingly, if the trustees make partial terminations of the widow's life interest in her lifetime, say by accelerating the interests of the remaindermen, then these are treated as potentially exempt transfers made by the widow (under section 52(1), Inheritance Tax Act 1984). Technically, if the trustees were so minded, then they too could 'load' the inheritance tax this time onto the free estate, in the manner described by 'Up the Wall' as a 'planning tool', provided they have power to do so under the terms of the trust and they are exercising their dispositive powers correctly.
The phrase 'the tax tail wagging the dog' springs to mind in situations like this!
'Up the Wall's' client should not allow any desire she may have to increase the inheritance tax burden on her late husband's children (by making gifts) to outweigh the need to retain sufficient assets in her estate for her own long term protection. - Blackdog.
Extracts from further replies received:
Liability for tax attributable to the value of property comprised in a settlement at death devolves upon the trustees (section 200(1)(b), Inheritance Tax Act 1984). It is the deceased's estate which section 199 makes liable for the tax on value transferred by a potentially exempt transfer, often escaping tax by reason of the threshold. See examples in 'The Perils of Cumulation' by John Newth in Taxation, 3 November 1994 at pages 111 to 114. - Bear.
The planning point suggested is well founded. The accountant or tax practitioner would be well advised to monitor the client's potentially exempt transfers to keep track of those attaining exemption and the level of taper relief on the rest, to find the amount at risk.
Given the rate at which the inheritance tax nil band tends to rise, if £1,000 is added to the amount at risk for each year of the widow's reasonable life expectancy, she can be enabled to ensure that all the nil band is applied to her gifts.- Barham.
