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Taxes are never popular, but Inheritance Tax (IHT) is arguably subject to more criticism than any other. Often referred to colloquially as “death tax”, it is a levy that is placed on estates that are worth more than the IHT threshold.
In March 2021, the government announced changes in IHT which will become effective from January 2022. The unpopular tax is not being abolished, but the upcoming changes will make it much easier for estates that are both under and over the IHT threshold.
Below is a brief summary of when Inheritance Tax applies and how it will be administered from January 2022.
What Is IHT?
Inheritance Tax (IHT) only applies when someone dies and is a tax that is applied to the value of their estate. This means that beneficiaries named in the will may not receive everything they expect as the Executors must pay up to 40% of the value of the deceased’s estate above the tax-free allowance, currently £325,000, in taxes.
An estate is defined as the belongings that a person owned, including property, savings and other assets. The value of the estate is calculated by taking the total sum of all assets and deducting funeral expenses and debts. This provides the net value of the estate, and it is this figure which IHT is based on after the tax-free allowance is taken into account.
Not every estate is subject to IHT. There is a threshold, set by the government and subject to change, and only estates which are worth more than the threshold must pay IHT. The current threshold is £325,000. Anything over £325,000 (or any new threshold which is announced) is subject to tax at 40%.
There are some steps that can be taken to reduce IHT, and some ways to transfer allowances. If you think your estate will exceed the IHT threshold, it is advisable to obtain financial advice from an IHT planning expert.
Changes In IHT Reporting
When an individual dies, either the executors of their will or the administrators of their estate will need to complete the relevant returns for IHT.
The Office of Tax Simplification (OTS) carried out a review on IHT, including the process of reporting IHT following a death. The OTS recommended sweeping changes to the way in which IHT is reported, thereby making it easier for estates to be administered.
Their advice included moving to a fully digitised system with Probate applications that could be submitted online in their entirety. The government has not accepted the recommendations in full, but as a first step is simplifying the process.
From January 2022, there will be no mandatory requirements for reporting for any estate which falls below the IHT threshold. This means if the estate is less than £325,00 the executors will no longer have to file IHT paperwork.
In addition, there will no longer be a need for physical signatures on an IHT return for any issues relating to either the estate or a trust. This change was introduced as a temporary measure due to the global pandemic but from January 2022, it will be made permanent.
New HMRC Guidance On Spouses
In addition to the new simplification of reporting which will be effective from January 2022, HMRC has also defined the definitions of spouse and civil partner. Up until this guidance, there has been no definition within IHT for spouses and civil partners so the general law definition has been used.
There are exemptions in IHT for transfers between spouses, enabling an estate to bypass taxation so a correct definition is key to IHT law.
HMRC has confirmed the following are considered to be spouses under IHT law:
- People legally married to each other, including same sex couples
- People who are legally registered as civil partners
- People who are legally married but separated at death
- People within a valid polygamous marriage
The guidance goes on to confirm that individuals who are cohabiting, regardless of the length of time, are not considered to be spouses for the purposes of IHT law.
More Changes Forthcoming?
Along with recommending digitisation, the OTS also made a raft of other suggestions which would radically reform IHT.
If adopted, the changes would completely change the way IHT is administered and how the amount due is calculated. It includes measures such as excluding payments from life insurance policies, without the need to put them into Trust, and exemptions for lifetime giving.
In March 2021, the Treasury Select Committee acknowledged the recommendations made and stated that they believed there was a “compelling case” for the reformation of IHT. Two months later, the Organisation for Economic Co-operation and Development (OECD) released their own report on IHT in OECD countries. This ran along similar lines to the OTS report, advocating for the simplification of IHT administration and addressing inequalities.
The changes forthcoming in January 2022 will be welcomed by anyone with responsibilities for administering an estate, but it is clearly only the first step with much more yet to come. The government has acknowledged that it has not accepted the recommendations from the OTS in full. A letter from the Treasury to the OTS confirmed that the government will continue to work towards digitisation and a more “longer-term” overhaul of tax administration.
There has not yet been any commitment from the Treasury to change the structure of IHT in line with the recommendations from the OTS or the OECD. Experts believe that the financial pressures of the global pandemic may be playing a role in government strategy. The nil rate band of £325,000 has not been changed since 2009 and it was widely expected to be increased in the Spring Budget of 2021.
Instead, the Chancellor announced that the threshold for IHT would be frozen until 2026 at least. Together with freezing the Residence Nil Rate Band (an extra allowance that applies to some types of IHT), it is predicted that the government will raise an extra £985 million.
Therefore, while digitalisation and further simplification of administration may be introduced, there are unlikely to be any wholesale changes that reduce the amount of revenue the government receives from IHT.