Estate planning is an effective way of arranging your affairs in order to minimise how much tax you are liable to pay. There are two taxes to consider in the disposal of assets these are Capital Gains Tax (“CGT”) and Inheritance Tax (“IHT”).
CGT is a tax that is charged on “the gain when a chargeable person (a resident of the UK) makes a chargeable disposal (sales of gifts) of chargeable assets (essentially all property, except cars and certain life policies).” CGT is charged at 18% for basic rate taxpayers and 28% for higher rate tax payers, personal representatives of a deceased person’s estate and trustees.
Whereas IHT is a tax on the estate (the property, money and possessions) of someone who’s died. The standard rate of IHT is currently 40% and is only charged on the value of your estate that is above the threshold which is currently £325,000 (“nil rate band’). However, IHT is not payable on the following:
- The value of the estate is below the nil rate band; or
- Your entire estate is left to your spouse or civil partner, a charity or a community amateur sports club.
When considering tax planning there are various factors to take into account, in particular:
- What property should be used
- Who the property should be given to
- What is the best way of it being given away
- When should the process take place
1. What property should be used
Whilst there are benefits to tax planning it is important to note that once assets are given away they cannot be claimed back.
2. Who should the property be given to?
Gifting property to your spouse or civil partner can be an effective tax planning strategy. In addition, it provides financial security, particularly if one of you earns less. An example of this is transferring assets to another in order to make use of the others annual exemption for Capital Gains Tax (“CGT”) and Inheritance Tax (“IHT”).
Another effective method is to transfer assets that produce income, such as shares, or rental property, to your spouse who is a lower rate tax payer. By doing so you can ultimately increase the overall tax bill between the two of you.
In terms of IHT, as previously mentioned gifts made between spouses are exempt. However, it should be noted that this is limited to £325,000 for transfers from a domiciled spouse to a non-domiciled spouse. It is also important to note if your married or in a civil partnership that any of your unused threshold can be transferred to your partner at the time of your death. As for CGT, there is no immediate CGT payable in relation to transfers between spouses.
Should you give away your home to your children (including adopted, foster or stepchildren) or grandchildren your threshold may potentially increase to £500,000 for IHT purposes.
Other exemptions to CGT include:
- Wasting assets and chattels such as cars, plants and machinery. Chattels worth less than £6,000 are also exempt which can include items such as jewellery;
- Hold over relief which is a form of tax postponement, whereby there is no immediate CGT payable and it is differed until the done disposes of the asset. It is important to note however that for CGT purposes the donee will acquire the asset at the donor’s acquisition cost;
- Principal private residence whereby your main residence is exempt from CGT; and
- Business reliefs which are only relevant where the focus is more sales and reinvestment than making gifts.
3. What is the best way of it being given away?
There are three methods of giving away property. These are by way of an outright gift, by setting up a trust and transferring property from your sole name into joint names. There are various advantages and disadvantages to each method and the ideal method will depend on the property being transferred and the circumstances. Transferring property by way of an outright gift is often the easiest and most inexpensive method. However, as mentioned once property is given away it cannot be taken back making the method inflexible should there be a change of circumstances. In contrast giving property away through a trust is more flexible and is ideal for individuals with complex objectives. The downside to this method is that it requires professional advice which in turn makes the method more time consuming and costly.
4. When should tax planning take place?
It is important to note that take planning is a continuous process and can take place during a person life by way of lifetime giving or at the time of death through a will or even thereafter by way of a post death variation.
An effective method of tax planning is to make Potentially Exempt Transfers (“PETs”). PETs allow the you to remove assets from your taxable estate during your lifetime. By doing so you can ultimately reduce the amount of IHT payable. However, in order for a PET to be exempt from IHT the donor will have to survive the gift by seven years. Potential obstacles include the reservation of benefit rule and the pre-owned asset rule both of which prevent donors from giving away property which they still retain a benefit from or interest in. There are however exceptions to both rules.
Tax planning can also take place in a will. When drafting a will, it is important to note whether the Nil Rate Band will still be available on death and whether there should be a discretionary trust which could have potential IHT benefit
For more information, please contact our team who will be more than happy to help you.