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Inheritance Tax: how to avoid an investigation

Inheritance tax (IHT) affects a growing number of people and is the focus of increasing attention from HM Revenue & Customs.

 

by Michelle McGagh on Sep 16, 2013 at 09:00

Inheritance Tax: how to avoid an investigation

Acting as executor on a loved one’s will isn’t easy and it’s made harder if the tax man scrutinises the arrangements. Thanks to rising house prices the number of families being hit by inheritance tax (IHT) has steadily increased over the past three years.

IHT doesn’t kick in unless the deceased’s estate, including property, savings, pensions and investments, exceeds £325,000 – this figure is known as the nil rate band (NRB). But if the estate is worth more than that 40% tax is paid on the amount over £325,000.

It’s not just house price and, in some cases, stock market rises that have pushed more people into the IHT net. In 2009 the government froze the nil rate band at £325,000 meaning it has not kept pace with inflation. In real terms the nil rate band has been shrinking. This is set to continue until at least 2015 as the government needs money to pay for reforming long-term care for the elderly and infirm.

According to the Office for National Statistics, the amount of IHT collected by HM Revenue & Customs (HMRC) peaked at £3.8 billion in 2007/08 during the housing boom and then fell back when the property market crashed. It then climbed back to £2.9 billion in 2011/12 and hit £3.1 billion in 2012/13.

Dave Downie, technical manager at Standard Life, the pension and investments group, said IHT was not just an issue for the very wealthy as families with modest homes in London and the South East were now affected. As more people are hit with IHT bills, the tax man has become more interested in tackling evasion.

He said IHT is ‘something [HMRC} has thrown a lot of resources at’ and it is ‘beefing up’ its investigations departments.

Red flags

Most people don’t deliberately try and defraud HMRC but equally they're unlikely to have been an executor before duties or encountered the rigmarole of IHT. It’s no surprise that mistakes are made and investigations take place.

If HMRC singles you as an executor out for an IHT investigation, don’t panic. It is likely that you have been picked at random as part of a sample. In a worst case scenario something you have done when dealing with the estate has been red-flagged by the taxman.

Downie said there are certain things that would draw HMRC’s attention.

‘There will be red flags for HMRC and they will do random sample checks as well. The bigger the estate then the bigger the sample size will be,’ he said.

‘Red flags would be an estate that falls conveniently just below the IHT threshold, if HMRC sees that there will be more scrutiny. They are also looking out for unrealistic valuations for property. They have records of likely house pries and if you have a three-bed house in the South East that is valued at £200,000, then that will be flagged up.’

Undervalued properties are a particular hotspot. In 2011 more than 9,300 IHT investigations were launched. On average £24,600 extra tax had to be paid following the HMRC's inquiries.

Under investigation

Unfortunately the onus is on the executor to prove what he or she has done is correct if there is an investigation. If you happen to be an executor of someone’s estate don’t try and omit details.

‘It is a case of making sure you answer everything in your IHT return as truthfully and accurately as you can and hope that the person whose estate you’re dealing with has left it in good order,’ said Downie.

Once you are placed under investigation you will receive fact-finding documents from HMRC and be asked to fill in a questionnaire.

The important point is to be honest. If you haven’t done anything wrong then you won’t have anything to worry about.

HMRC usually looks for irregularities in property and large estates. It is not so concerned with small gifts which the deceased may have given to family members and friends in the years before their death.

Everyone has gift and annual exemptions which mean they can give money away to loved ones without fear that the money will then be taxed by HMRC if they die within seven years (the time limit for 'potentially exempt transfers'). Larger sums that are given away, say for a housing deposit or to pay for education, also fall outside IHT if the deceased survived for seven years after making the gift. For more read 'How to avoid inheritance tax'.

Tax in life and death

HMRC may not scrutinise small gifts but Downie said it will focus on gifts that could possibly have incurred tax in life as well. For example, a gift to a trust could incur a charge on death but also could have incurred tax when the person was still alive, depending on the type of trust used.

IHT investigations can also cause problems for people who received gifts while the individual was still alive if they did not fulfil any tax reporting requirements at the time.

‘If you have received a gift then you have an obligation to register it and fulfil any tax reporting,’ said Downie, referring to the knock-on tax implications of receiving a gift such as interest on cash or rental income on a property. ‘This is the type of thing HMRC will use as evidence in its investigations.'

Downie said it was no good trying to hide gifts from HMRC as there was always a ‘ripple effect’ of paperwork that will lead the taxman to the money.

‘Property is easiest to trace because you have the Land Registry and stamp duty records but money can be traced from an account transfer, or if cash is placed into an account there may be a lump sum of interest paid on it,’ he said.

HMRC has a lot of power to access personal records if it believes there is something untoward going on. Downie said if it suspects fraud it can access the bank accounts of a person it believes to have benefited from a deceased person’s estate.

Left in the lurch

Most executors try to do the best job they can but if they make an honest mistake and fall foul of the rules HMRC can fine them up to £3,000 plus a charge of 200% of the outstanding tax, even if the executor wasn’t a beneficiary of the gift.

To prevent a loved one being placed in this situation, the best thing is to make provision while you are still alive.

‘The more information you can leave the fewer problems the executors will have,’ said Downie. ‘Make records to help you executors forensically put back together your accounts.’

Downie said that as the stockmarket and housing markets are improving again, IHT planning was becoming ‘more prevalent’ and although thinking about death is a difficult thing to do, it will be even more difficult for your family to piece together your finances without any records.

For more information on IHT and will writing, check out these guides from The Lolly:

25 comments so far. Why not have your say?

Malcolm

Sep 16, 2013 at 15:36

‘If you have received a gift then you have an obligation to register it and fulfil any tax reporting,’ said Downie. ‘This is the type of thing HMRC will use as evidence in its investigations.'

Since there is no gift tax, what legislation exists for a recipient to record and register any gift to HMRC?

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John Donald

Sep 16, 2013 at 15:56

Malcolm,the statement by Standard Life is misleading to say the least.Gifts to individuals are only subject to IHT if they are above the exemptions and the donor dies within seven years.

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Robert Rutherford

Sep 16, 2013 at 15:59

Good question Malcolm - I think the answer to that is NONE other than to pay any resulting taxes on interest or capital gains!

However, one point that perhaps could have been made is, when making a substantial gift e.g to a son/daughter on marriage and using the allowance, it is worth while to write a letter to them making it clear not only what allowance you are utilising but also that any subsequent IHT would be payable by the estate. Of course that latter provision only works if the estate has the money to pay. Keep a copy on file for the executor also.

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peter montgomery

Sep 16, 2013 at 16:46

IHT is a pernicious tax which should have been abolished decades ago.It was originally bought in by a Socialist Govt(who else!) and designed only to affect the really well off. As with income tax-or the dangerous dogs act-it stayed around and had unintended consequences.The really wealthy dont pay it-via farmland reliefs etc-so yet again the squeezed middle get clobbered.And,if Comrade Balls and his bunch of spendthrifts squeeze in ,in 2 years time,they will double the rate.

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peter hart

Sep 16, 2013 at 16:59

You can give away what you like out of income as long as you don't spend your capital to maintain your normal standard of living. I only drink water and live on scraps.

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Philmo

Sep 16, 2013 at 17:34

@ Peter Montgomery

Not so - the concept has much deeper roots!

From those who have, to those who need. Biblical I believe.

For those who are equitable and altruistic in their life philosophy, it's not an unreasonable tenet.

There are only two ways to become wealthy:

1] Inherit it

2] Take it from others - by fair means or unethical. And the greater the wealth, the greater the likelihood of scant ethics, regardless of legality!

I have nothing but praise for Warren Buffet and Bill Gates re their approach to inheritance and good works.

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Diabla

Sep 16, 2013 at 17:53

I am thinking of putting money into cash iSA's in the names of my two sons in order to reduce possible inheritance tax. Will they have to declare these to the taxman and pay tax on the amounts put in their names?

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Roger Savage

Sep 16, 2013 at 19:37

"said IHT is ‘something [HMRC} has thrown a lot of resources at’ and it is ‘beefing up’ its investigations departments"

Sums up all you need to know about the UK and the tax authorities.

Spongers (indigenous and imported alike), criminals (who pay zero income tax) and those 'well-connected' don't contribute a bean (in money or to society in general) but people who have worked all their lives, been prudent and put something by for themselves and their families have their assets taxed and taxed again ad infinitum in life and in death.

The authorities profiting from death (and putting a lot of effort into the same) is pretty much as distasteful as it gets.

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alan thompson

Sep 16, 2013 at 23:11

Spot on RogerSavage I totally agree, you summed it up perfectly ,nothing more needs saying on the subject..

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A. Goodman

Sep 16, 2013 at 23:43

I agree with Peter Montgomery, IHT is a most pernicious tax both in principle and in the way it works. The "zero rate band" has never kept pace with inflation. The £3,000 per year allowance has never been increased since the IHT started. The small gifts exemption of £250 is derisory and has also never been increased.

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Philmo

Sep 17, 2013 at 00:26

Disagree - it's not the tax which is pernicious - but the way bin which it is being administered - for good reason though, to capture more during a time of need.

What really grates, as RS et al have said, is that the wealthy and their lawyers in HMG continue to leave loopholes permitting avoidance for themselves and wealthy cronies.

Also it's high time HMRC used their teeth on the avoiders, worked more closely with ipsa etc to level the playing field.

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michelle mcgagh

Sep 17, 2013 at 09:15

Hello Malcolm,

To answer your question. You are right, there is no gift tax as such but what Downie is referring to is if you are given a gift - for example a cash lump sum you must declare the interest, and if you are given a property you must declare income from rental for example.

He is talking about the possible knock-on tax implication of receiving a gift - I should have made this clearer and thank you for flagging.

Michelle

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James Keble

Sep 17, 2013 at 12:39

My computer crashed without back up and I lost all my financial records other than my tax returns and an analysis of their composition. Other than Christmas and birthday gifts nothing given to descendants. How do I stand

other than being a complete idiot? I am pretty aged therefore unlikely to live much longer

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peter hart

Sep 17, 2013 at 13:27

As I said earlier you can give away what you like if it is out of income and does not affect your standard of living. Also HMRC will usually count income as what you have saved from same over the last three years.

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Ladysaver

Sep 18, 2013 at 16:08

The Standard Life man wasn't being misleading when he talked about gifts that can incur tax during the donor's lifetime. He said: "For example, a gift to a trust could incur a charge on death but also could have incurred tax when the person was still alive, depending on the type of trust used". Some gifts into trust DO incur tax at the time they are made (and further taxes later on the assets within the trust). He also refers to gifts of cash or property during the donor's lifetime that bring taxable income to the donee, e.g. interest on cash or rental income. He seems to mean that if the taxman spots gifts that have been made when the donor dies, he might discover that the donee had not been declaring the taxable income. This isn't really anything to do with IHT - it would be income tax evasion.

Re the query about putting money into cash ISAs in sons' names - no, neither you nor they they need to declare this at the time the money is given, and the sons don't need to pay tax on it, as income from ISAs is tax-free. The money would be a gift to each son at the time it was made, and would fall out of your estate after 7 years, so it would be wise to keep records of when the gifts were made. You can give away up to £3,000 a year without it counting for IHT, so if you gift the whole cash ISA limit, the £3,000 allowance would cover some of it. Depending on your other income - i.e. if you're in a position to make gifts of the full cash ISA amount to your sons' ISAs regularly out of your income, without it affecting your lifestyle - your executors might be able to argue that the ISA gifts were regular gifts out of income and thus might escape the IHT net entirely.

IHT is a pernicious tax, most notably for the way it taxes savings that have already been taxed in the person's lifetime. Our children face a tougher future than we did, of far more expensive housing, huge university fees, job insecurity and terrible pensions. Saving to try to help them when you've passed away is a decent thing that almost everyone hopes to be able to do, but the government wants to grab more and more of it. Some politician once said IHT is a tax for people who hate their heirs more than they hate the taxman. There's still something in that. Give away as much as you can afford when you're still alive, make maximum use of the annual allowances, and keep hoping that (a) the Conservatives revive their promise of exempting your home from IHT and (b) get back to power and into a position where they can implement this.

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michelle mcgagh

Sep 18, 2013 at 16:10

Hello James Keble

If you have only given birthday and Christmas gifts you should be fine as, unless you are incredibly generous, I am assuming are within the permitted allowance of a few hundred pounds per year.

Contact your bank and ask them to send you account statement, the same for any ISAs, pensions or investments you have. Even if tax isn't due on the gifts it is beneficial to have all your statements in order so your executor can access all your financial records with ease.

Hope that helps

Michelle

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Robert Court

Sep 22, 2013 at 11:40

There's a philosophical side to all this. I believe in immortality via the gene.

I'd like to set up a family trust [if I ever have enough dosh to make this feasible] and somehow benefit the most financially adept of all future generations............. after all if a financially bright lad or ladesS could turn every £1k into £100k then he/she might help provide for siblings etc.

The thing is to provide for both any IHT plus the ravages of inflation.

I'd set up a trust so that the beneficiary only received say 10% of investment income from age 'x' and increasing by 1% per annum until he/she received a maximum of 20% of total investment income per annum.

He/she would have an input into the investment decisions and also decide which family member would benefit when he/she died with the instruction to choose the most able.

IMMORTALITY 'guaranteed' - ~ish~

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normski 2nd

Sep 22, 2013 at 11:54

Morning folks,

I would like to know the details of how Mr Osborne and Mr Cameron intend to hang onto their money, then I could do the same.

normski

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Alan Phillips

Sep 22, 2013 at 12:00

There are many people in UK with nothing wrong with them but claim sickness benefit,invalidity,disability,car allowance etc..etc.They usually sit in pubs all day.If Balls and co.get into power they will be better off and the squeezed middle classes who pay the inheritance tax (the rich do not pay it) will be worse off. It's one half of the UK working hard to keep the other half.Why bother?

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Diabla

Sep 22, 2013 at 13:48

I am sad to say that I now agree with the above. Having been a social worker for over 20 years, my opinions changed in that time. In the beginning I was taking families to the DSS to help them with benefits. After 20 years I was pleased to get out as I really didn't like the resentment I felt when I saw how much of their benefits was being spent on alcohol, cigarettes, cars and even holidays! No they didn't own their own property as I did but often their spending was far in excess of mine and they had no pension worries! I was not one to snitch but honestly the abuse of incapacity benefit and disability living allowance was rife. Parents were keen to have their children labelled with ADHD in order to receive all the accompanying benefits. A sad state of affairs.

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Robert Court

Sep 22, 2013 at 14:21

Some people are genuine cases; however it is very easy to become a victim of the benefits system. It is no longer a shame to be unemployed or in receipt of benefits. An alcoholic or drug addict can go to a church for charity but shall only be given food NOT money. Benefits should equal charity and be given as a last resort to people fallen on hard times NOT as a right!

Pensions are a 'right'. Benefits are a 'right'. The NHS is a 'right'. Etc.

No!

All the above are the result of a caring society and when a government IN GOOD FAITH takes account of the needs of the electorate then it AUTOMATICALLY brings in the possibility of abuse.

We need to go back to basics and realise that all government benefits that we contribute to are a form of charity and NOT self reliance which the majority of people should be able to achieve - i.e. the MAJORITY of us should be able in our working lives be able to take care of ourselves apart from times when we EXCEPTIONALLY fall sick or incapable of work or capable of providing for our old age.

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Robert Court

Sep 22, 2013 at 14:25

I think I made a few mistakes in the post above but:

1.) We should be self reliant

2.) If we have more than we need we should help others

3.) Those on the receiving end must realise that they are in receipt of charity - whether from some welfare state or generous individuals/organisations.

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Philmo

Sep 22, 2013 at 15:28

@RC

If we've paid for it or are paying for it, then it's a right!

NOT charity at all, they are simply national form of insurance/pension run by HMG.

There should be a qualifying payment period, after which entitlement to the payout is accrued, NHS excepted, which must be available to all at all times.

IMHO!

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Mike_B

Sep 24, 2013 at 10:05

Is it not preferable to have your money taxed after death, rather than before?

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Gwyn Jones

Sep 25, 2013 at 03:37

Would the following work for someone who fears the HMRC and the family , and can also not afford to set up and run a trust to avoid an IHT liability.

1. Gift the family home to a close relation and stay on as a freserved life tenant paying a full commercial monthly rent set by an independent valuer that the recipient recycles by creaming off say 20-25% for the rental income tax bill with the surplus baing handed back to the donor to fund the next month's rent and so on. Over the years may be cheaper than an IHT bill or paying for life insurance cover to fund the IHT cost.

2. Gifting a buy to let out residential or commercial property as opposed to the family home to a clsoe relation with a leaseback being reserved for the lifetime of the donor at full rental value to enable the donor to then sub let to a private tenant at the same rent paid to the relation.

3. Gifting a residential or commercialproperty to a close relation subject to the relation entering into :

a.a pre nuptial arrangement on marriage under which the gifted assets would be exluded from any future divorce settlement or the right would be reserved to buy back the gifted asset for a nominal sum in the event of the premature dissolution of the marriage or the death of the close relation.

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