With a new approach to inheritance tax law, the Government aims to boost gifts to charity but encouraging people to give more away can also benefit their children and others who stand to inherit. Here, legal expert Danny Carter of Gepp & Sons provides an update on the latest changes and how they can be used to benefit both charities and those inheriting.
Giving money to those in need, rather than the taxman, is likely to have universal appeal so the news that donating to charity can result in a lower tax bill sounds like uncharacteristic cost-cutting behaviour from the taxman - but that’s the effect of a recent change in inheritance tax law, where money is being left to charity.
It’s a new regime which was announced last year by the Government, which saw the introduction of an Inheritance Tax rate of 36% where 10% or more of an estate is given to charity. Now in force, it applies to any death taking place on or after 6th April 2012, and even if the opportunity wasn’t planned for, executors and beneficiaries can still elect to take advantage of the change in the law.
To understand how it works, we need to look behind the banner as the new rules divide a person’s estate into three possible component parts, which has a big impact on the relevant figure used for the bottom line calculation. So although it may seem that 10% is a big chunk, it is unlikely to need to be anything like 10% of the headline figure of the value of the estate. The three parts are:-
- Free estate; that is, what the deceased owned in their own name.
- Joint property passing to the surviving joint owner; eg a house or bank account jointly owned with their surviving husband or wife.
- Interests under a trust; eg a right to live in a house or a right to receive the income from a portfolio of shares.
The taxman then looks at each of these individual component parts to assess whether the 36% tax rate may be applicable on tax due, where 10% of that particular component part is given to charity.
And it doesn’t stop there. In calculating the 10%, there are other things that may be taken out of the equation. For example, property that attracts other exemptions or reliefs is disregarded. These include the nil rate band (the first slice of your estate that is allowed to be passed on before inheritance tax kicks in, which is currently £325,000); or the surviving spouse exemption or agricultural or business property relief.
The effect is to dramatically change the amount that is used for the 10% calculation – so although a charitable gift might appear to be much less than 10% at first glance, after all the sums it might yet be enough to qualify for the new lower tax rate.
So how does this work in practice? Let’s take a simple example and work through the calculations:
John dies owning:
- A trading business – or this could be a farm - valued at £5,000,000
- A half share in aLondonflat - the total value of which is £500,000
- Cash and investments worth £1,000,000
In his will he leaves:
- The business/farm to his son
- His share in the flat to his wife, who owns the other half share
- A further lump sum of £500,000 to his wife
- £25,000 to charity
- The rest of the estate to his daughter, i.e. the remaining cash / investments
In this example, it looks as if the gift to charity is a very small proportion of the estate. But let’s work through the sums.
Firstly, the gift of the business or farm to the son is ignored because it attracts 100% business property or agricultural relief.
Secondly, the gifts to the wife are ignored because they attract the surviving spouse exemption.
Finally, the nil rate band is deducted from the remaining £500,000 leaving £175,000 (remember, the nil rate is how much of an estate attracts a zero tax rate – currently £325,000).
So now we can see that the gift to charity is actually worth more than 10% of the ‘bottom line’ figure for the estate of £175,000 - so in this example, the ‘free estate’ component would attract a tax rate of 36%.
This new regime can be extremely attractive for those who want to give significant sums to charity and if you get the sums right, large amounts can be given to charity without any loss to the beneficiaries.
If you get the sums right, making a gift of 10% of the estate, can leave the beneficiaries with exactly the same amount as if there were a gift of 4% of the estate to charity. The increase in the charitable gift is paid entirely by the tax saved.
So in the example above, making a £25,000 donation to charity leaves the daughter with exactly the same amount after tax as if the charity had been given £15,000, keeping it at the standard 40% inheritance tax rate, so there’s an incentive to give more away to get the lower tax rate, for a win-win situation.
The message is that if you want to make a substantial gift for charity, this can be paid for by the tax saved.
Yes, the calculations can seem a bit tricky but I would expect that there will be an increase in post-death variations of wills, where executors and beneficiaries agree that it would be better to make a donation to charity which hits the 10% mark to bring a resulting cut in the inheritance tax rate – and that is perfectly acceptable under the new rules.
But for anyone who is currently undergoing estate planning, and wanting to take advantage of the new rules, the best option is to do a new will that is tailored specifically to this new regime.
It’s not often that the taxman offers to cut the bill, and if it means your favourite charity gets to give more help where it’s needed, it’s not an offer to dismiss lightly.
This is not legal advice; it is intended to provide information of general interest about current legal issues.
If you require any further information or would like advice on inheritance tax issues and planning for the future please contact us on 01245 228122, complete our enquiry form or email firstname.lastname@example.org