There are a lot of misconceptions about the legality of reducing tax charges. While it is an area that must be navigated with care, in most cases, there are lots of legal opportunities for individuals to reduce the amount of tax they will be charged on certain transactions. Reducing tax is usually done by utilising structures endorsed by HMRC, and should be approached with the assistance of legal professionals who can advise and guide you through the whole process to ensure tax compliance.

In the following guide, the experts at JMW have outlined the various ways you can use your circumstances to your benefit and reduce the charges of inheritance tax that you may otherwise incur.

What is Inheritance Tax?

Inheritance tax is incurred on the value of the estate and property of someone who has died and is deducted as part of the administration process. In certain circumstances, Inheritance Tax can also be levied during a person’s lifetime. Broadly speaking, the tax only applies to estate and property that has a value of £325,000. Additionally, inheritance tax does not have to be paid if everything above the threshold is left on death to one of the following:

• The deceased’s spouse or civil partner;
• A charity; or
• An amateur sports club.

Further to this, the threshold can be increased to £500,000 if a deceased person’s main home is passed to the deceased’s children or grandchildren (lineal descendants) and a number of other criteria are satisfied. These points are essential to consider when estate planning, as the standard inheritance tax rate is 40% - charged on the value of the estate and property above the relevant threshold. In order to maintain the value of an inheritance, you should consider what reliefs may be available to the estate, whether you are planning for your own family or expecting to receive an inheritance.

Set Up a Trust Fund

A trust fund allows a person to transfer assets for the benefit of another individual or class of persons. The trust is managed by people called “trustees” and the people who can benefit are called “beneficiaries”. The person establishing the trust is the “settlor”.

One goal of setting up a trust fund is to provide these financial assets to the beneficiary without incurring inheritance tax, increasing the finances that they will receive. Trusts are also used for protection purposes, ensuring that a beneficiary does not have unrestricted access to money at an inappropriate time (for example as a result of financial immaturity, matrimonial disputes or addiction).

Trusts can be set up and distributed during the settlor’s life, or included in a will as a process set in place to ensure that the beneficiary can be financially supported after the settlor’s death.

Trusts can be set up and distributed during the trustee’s life, or included in a will as a process set in place to ensure that the beneficiary can be financially supported after the trustee’s death.

Charitable Gifts

One way that can reduce the inheritance tax rate by a small amount is to leave 10% or more of an estate when someone dies to charity. This is calculated based on the net value of the estate, which is the value after debts are deducted. This can reduce the inheritance tax rate to 36%. The part passing to charity is also free of Inheritance Tax.

Tax-Free Gifts

Gifts can be anything from sums of money to houses and shares in companies. Gifts that the donor made during their lifetime can be taxed as part of the estate after their death if they fail to survive for seven years. However, there are some exceptions to this:

• Gifts exchanged between spouses will have no inheritance tax applied to them (with some limited exceptions where the recipient spouse is not UK domiciled);
• Gifts given to political parties (with limitations) or charities incur no Inheritance Tax;
• Gifts worth up to a total of £250 can be given per person without incurring tax, but only if no other allowance has been used to provide them with other gifts;
• Gifts provided to those getting married or entering a civil partnership (with limits); and
• Gifts made using the annual exemption.

There is an annual exemption amount of £3,000 which allows for the giving away of assets without inheritance tax, provided the total value of these gifts does not exceed the £3,000 limit in a year. Any of this allowance that is not used can be carried forward into the next tax year, but not into the one following that.

For gifts given to those entering marriages or civil partnerships, there are limits of up to £5,000 for a child of the person making the gift, £2,500 for a grandchild or £1,000 for anyone else. Only one gift can be given yearly in this way, but these can be combined with the annual exemption, allowing for a larger value of gifts to be granted to a single person - up to a maximum value of £8,000.

Taper Relief

Inheritance tax incurred on gifts is paid out when the estate is being administered. There is a seven-year exemption rule that states that no inheritance tax must be paid on gifts that were made more than seven years prior to the donor’s death.

Additionally, taper relief decreases the amount of inheritance tax that must be paid on gifts that were given over time in increments. Gifts that were given over three years prior to the death of the donor only incur a 32% rate, while those given over four years only incur a 24% rate, and the five and six-year bands are even lower - 16% and 8%. Taper relief applies only to gifts which are made and which exceed the Inheritance Tax threshold - currently £325,000 per person.

To properly assess these gifts based on the time they were given out, the person managing the will, property and estate - the executor - will require records of them, so it is essential that the donor makes and keeps these.

Expenditure Out of Surplus Income

This is a method of gifting cash that allows the donor to make unlimited amounts of gifts (without the seven-year survival rule applying), provided that the donor can still meet their own living costs from their remaining income.

This can also be combined with other allowances, such as the annual exemption.

Business Relief

Business relief for Inheritance Tax specifically applies to the value of a business and the assets it owns. As the value of these is included in the calculations for Inheritance Tax, it is important that donors who own businesses understand how they can use business relief to their advantage.

This relief can be 50% of the market value of the business and its assets, or 100%, and can be applied when distributed during the donor’s lifetime or after the donor’s death.

Business relief can be claimed on any property and buildings, unlisted shares and machinery that the business owns.

Life Insurance

While spending a portion of wealth on life insurance may seem counterintuitive at first, the insurance can provide the donor’s family with some extra inheritance tax-free financial support after the donor’s death while they are arranging the estate. It is crucial that such life assurance is held in trust (so that the proceeds do not incur Inheritance Tax at 40%) and JMW can assist with this structuring.