Are Inheritance Tax Rules Changing?

Could we soon see Inheritance Tax changes? It has been reported that the Government is considering scrapping Inheritance Tax (IHT) in advance of the upcoming general election. IHT is a controversial and generally unpopular tax, which has been labelled as ‘morally wrong’ by some. However, others argue that during a time of economic hardship, the abolition of IHT should not be a government priority. Could we soon see Inheritance Tax changes?

This is not the first time the Conservative Party have proposed changes to IHT. David Cameron promised to cut IHT in 2007 by raising the threshold to £1 million however, this was blocked by the party’s coalition partners at the time, the Liberal Democrats, following the 2010 election.

Current IHT Rules

Under the current tax rules, IHT is levied at a rate of 40% on estates to the extent that they exceed the Nil Rate Band, which can be up to £1m between married couples in certain circumstances. In addition, various reliefs are available to reduce an individual’s IHT exposure, including relief in respect of agricultural and business property, and gifts to charity.

Revenue Raised by IHT

Despite more than 93% of estates being expected to have no IHT liability in the coming years, the Office for Budget Responsibility forecasts that IHT will raise approximately £7.2 billion during the 2023/24 tax year. This means that around £7 billion a year could be lost in tax revenue by the treasury if the government opt to abolish IHT. This raises the question of whether an alternative form of tax would be introduced in its place, or if the government will simply scrap IHT entirely.

The Institute for Fiscal Studies has called for an overhaul of the current IHT system in the past, with their main criticism being that it is relatively easy for the wealthy to avoid, making it an inherently unfair tax. This is demonstrated by a report published by the Office of Tax Simplification which showed that the effective rate of tax on estates of £2 million was double that on estates of £10 million or more.

CGT or Wealth Taxes as a Replacement for IHT

A potential replacement for IHT is Capital Gains Tax (CGT). CGT as a replacement for IHT would likely work by way of assets being deemed to have been disposed of at their market value on death, triggering a tax charge. This would be a significantly more straightforward approach then under the current IHT rules.

Additionally, CGT may be a less unpopular way of taxing an individual’s estate after death as tax would simply be payable on the increase in value of the assets as opposed to their full market value at death, as is the case under the current IHT rules.

Another possible replacement for IHT is the introduction of a Wealth Tax, which was also discussed as a potential solution to covering the cost of the Covid-19 deficit. This may take the form of an annual charge on wealth in excess of a prescribed threshold.

However, a Wealth Tax would likely come with various issues of its own, including how assets would be valued each year, how tax would be paid by individuals who are ‘asset rich’ but ‘cash poor’, and determining the tax treatment where assets fall in value. As a result, this would be a complex replacement for IHT and likely unpopular.

PENSIONS

The tax rules have changed significantly over the past few years, with further changes announced in the most recent budget, abolishing the lifetime allowance and increasing the contribution thresholds.

Another change that is being reported as on the Government’s agenda is the Income Tax break on pension pots passed to beneficiaries on death.  Currently, beneficiaries of an individual who dies before age 75 can access the pension pot with no Income Tax charges.  There is, however, an Income Tax charge on the beneficiary where the individual lives beyond age 75; Income Tax is charged at the beneficiaries’ marginal rate when income is withdrawn from the pension.

It has been proposed that the position is aligned such that all pension pot withdrawals are subject to an Income Tax charge regardless of age at date of death.  There are some options being proposed such that an element of the pot can be withdrawn as a tax free lump sum, however, at the point it is withdrawn as a lump sum it leaves the IHT free pension wrapper and is exposed to IHT in the beneficiaries’ estate.  The ability to leave pension funds to pass down the generations IHT free is therefore more difficult.

MITIGATING EXPOSURE

IHT and pensions are complex areas of tax and it is important to obtain advice, whether you are seeking to mitigate IHT or make decisions about drawing down on pension funds.  Please do not hesitate to contact Jill Walker, Alex Thomson or your usual AAB contact.