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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
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.
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.
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:
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- IHT freeze will not help pay for long-term care reform, say accountants
- More people caught by inheritance tax: how to avoid death duty
- Government extends inheritance tax to pay for long-term care
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- How to avoid inheritance tax
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- Why you need to write a will
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