I do not know anyone who likes to pay tax, but many people have very different emotional reactions to different kinds of taxes. We barely notice that most of what we buy has 20% VAT added to the price; we accept as reasonable that our salary has some Income Tax deducted from it; and most of us think it’s correct that companies should be taxed on their profits. We might have less charitable feelings about Capital Gains Tax, but often accept that it is a sensible way of taxing those whose wealth comes from appreciating assets rather than income.
But everyone seems to hate Inheritance Tax (IHT) – why is that? It only accounts for 0.7% of the tax receipts in this country, and less than 4% of estates have any IHT to pay, but it is nonetheless a perennial political hot-button issue, and I know from my own clients the visceral rejection of the tax many people feel.
I do understand this sentiment. Some of the familiar arguments can be paraphrased as (1) “my wealth has already been taxed, why is it being taxed a second time?”; (2) “I’ve worked hard all my life for this money, and then the government is going to take it away when I die, it just doesn’t feel fair!”; or (3) “my children are going to have to sell the house to pay the taxes, and I want my family to continue living in our family home.”
A big part of the intensity of negative feelings about IHT is driven by misunderstanding and fear. Maybe I can help on those points.
First of all, many people worry about IHT who may not need to. For example, a married couple with children with a £900,000 house, £80,000 in savings, and a healthy pension pot will likely have no IHT to pay, due to transferable tax-free allowances between them which amount to a total of £1 million. Those tax free allowances are not the result of some expensive tax planning structure, but the standard allowances available to everyone.
But what about if you do have to pay IHT- will it mean the family home has to be sold in a rushed sale?
Almost certainly not. To state something that should be obvious, but may clarify things for some people, the headline IHT rate of 40% is levied on the estate above the tax free allowances. So in the example of our couple above, if their estate was actually worth £1.1 million, they would pay 40% on that £100,000 above the £1 million in tax-free allowances, or £40,000. As a percentage, that’s around 3.6% of the entire estate, hardly a punitive rate.
A point that is much less well understood is that HMRC does not want all the tax paid right away if there is a property in the estate, but only the first instalment. This first instalment is usually 10% of the tax owed on the property, and the full tax on the non-property assets. So let’s adjust our example – a married couple with children with a £1 million house and £100,000 in savings; in such a case the first instalment that would need to be paid is only £7,273, payable around six months after the death. The rest could be paid either in nine further yearly instalments (plus HMRC interest), of the estate could pay the remaining tax in full later in the process, for example by getting a small mortgage on the property.
How about with a more challenging situation, such as a single person without any children with the same assets as above, leaving the estate to their siblings? The tax in this scenario is a much higher £310,000 with a first instalment of £56,364. This is still not going to trigger a rushed sale of the property – the first instalment can easily be paid from the cash assets, and the remaining instalments could potentially be dealt with by getting a small mortgage on the property (a £250,000 mortgage on a £1 million property is a safe bet for most lenders).
I accept there are times when things are harder. To tweak our example a little more. Let’s say there are no cash savings, just the £1 million house, and a resulting £270,000 in IHT, the first instalment of which is £27,000. The first instalment needs to be paid to HMRC before the administration of the estate can proceed, but what if no one in the family has ready access to £27,000 in cash? This is sometimes what is known as the Grant of Probate ‘trap’. The Grant of Probate is the court order allowing the administration of the estate to proceed, but it cannot be obtained without the first payment of IHT to HMRC. If the only way of raising the money for the tax is by selling or mortgaging the property, but the property cannot be sold or mortgaged until the Grant of Probate is issued, families can feel stuck.
In these cases there are options available, the most common of which is for the executors to take out an executor’s loan. This is an unsecured loan where the lender confirms key information about the estate to determine the level of risk. For most estates, this risk is very low, and loans can be swiftly approved. The funds released by this loan pay the first instalment of IHT, the Grant of Probate is then obtained, and the executors and beneficiaries can proceed to either get a proper long-term mortgage on the property to repay the executor’s loan, or sell the property at a time of their choosing.
All this to say that IHT can be disruptive, but this is actually very rare, and there are some good options available for families worried about how they are going to deal with IHT.
For more information about IHT and the Grant of Probate process, please contact Alexander Mahdavi, Head of JPC’s Private Client team, by email amahdavi@jpclaw.co.uk, telephone 0207 625 4424 or connect with him on LinkedIn.
