Inheritance tax now affects us all In the second of our series on tax, we look at one of the most unfair: IHT or the Revenue's right to grab a share of the wealth you have built up over a lifetime. And it is the rich who are best at circumventing it.

The Sunday Telegraph  22/10/2006

By Mike Warburton The Tax Guru

With the possible exception of council tax, inheritance tax generates the most heated responses from the public. This is because it is inherently unfair.

When it was first introduced as capital transfer tax in 1975 by the then Labour Government it was intended to both raise money and re-distribute wealth from the rich to the poor - it was even promoted as a Robin Hood tax.

The reality today is very different. While the very wealthy can and do avoid the worst excesses of the tax, many ordinary hard-working families are being drawn into the net. As Tory chancellor of the exchequer Ken Clarke, in his last Budget Speech in November 1996, stated the Conservative Party's long-term aim to abolish inheritance tax.

Even Gordon Brown, when in opposition in 1994, said that the tax was unfair because it penalised ordinary people, and yet under his guidance the position has steadily worsened. The Chancellor has admitted 6 per cent of estates are caught for inheritance tax. Even that does not tell the full picture because in 38 per cent of deaths in the UK there is a spouse still living, so inheritance tax wouldn't apply.

The truth is that 10 per cent of households are already exposed to the tax. With asset values rising on average at 7.5 per cent per annum, but with the inheritance tax threshold rising at only 2.5 per cent in line with general inflation, more households are being drawn into the net every year. Based on figures produced for us by Lombard Street Research, by 2009 approximately 15 per cent of all households will be affected.

The Tory sponsored Tax Matters report has suggested that IHT could be scrapped - although George Osborne, shadow chancellor, has said he will not commit to any proposal for now. We are likely to be stuck with it for the foreseeable future, so what can we do to reduce the impact?

First and foremost, everybody with assets should make a will. For starters, only with a valid will can you be certain that your estate goes to the right people. Yet three in four people fail to make a will and die intestate. A will can help you cut your IHT liability. Everybody has an inheritance tax-free allowance, known as the nil-rate band, currently pounds 285,000.

If wills were structured correctly married couples and civil partners could take advantage of both their nil-rate bands, thus dramatically reducing the number of estates falling into the net. This can be achieved fairly easily for anybody who owns their own home.

Most married couples and civil partners own their homes jointly which means that on the first death the property would automatically transfer to the survivor. This means that no inheritance tax is levied on the first death and the nil-rate band is wasted.

Three simple steps can improve the position.
First, your solicitor can change the ownership of the property by severing the joint tenancies so that the property is held as tenants-in-common. In this way, the half-share that each partner owns can be transferred in accordance with their will.

Second, the will can set up a nil-rate band discretionary trust so that value up to that amount can transfer into trust at the time of the first death for the benefit of the spouse, children, or other heirs.

Third, the will can include a clause which gives the executors power to settle the amount due to the trust by means of an IOU against the surviving spouse. By this means all the property, or other investments, transfer directly to the surviving spouse, but the first inheritance tax nil-rate band is not wasted.

By taking the trouble to make a will in the right terms you not only save inheritance tax, but you will make life much easier for your family. If they have to suffer the trauma of your death, they don't want it compounded by financial difficulties because you did not bother to make a will. While you are at it, I recommend that people complete a "dying tidily log" which summarises all your assets, insurance policies, lifetime gifts, bank details, etc to make life as easy as possible for your executors.

Consider lifetime giving. Most people know that you can give pounds 3,000 a year without being hit by inheritance tax, but for many people the figure can be much higher than this. This is because regular gifts made out of your income, rather than capital, that do not reduce your standard of living are allowable on top of the pounds 3,000 limit.

In the last five years of my mother's life she paid pounds 20,000 each year on grandchildren's school fees, all of which was allowed by HM Revenue and Customs. Apart from that, you can make gifts of any amount directly to your heirs without paying inheritance tax as long as you live a further seven years. This is the way in which wealthy families are able substantially to reduce their tax liabilities as they are more likely to have excess assets to pass down the generations.

Since the Budget this year, it has been more difficult to do this using trusts without incurring an inheritance tax charge, but direct gifts, or gifts into a bare trust are still valid. Having said that, do not fall into the trap of feeling that you should be giving away your assets to your children simply to save inheritance tax.

The last thing you want to be is short of income in your old age.

(C) 2006 Telegraph Group Limited, London
Date: 22/10/2006
Publication: The Sunday Telegraph