Excepted Estates And The Changes From 1 March 2011 - Inheritance Tax

Inheritance Tax as part of probate

IHT forms are part of the probate process following a death, even if there is no IHT payable in respect of the deceased's estate. In cases where IHT is potentially due a 'full account' (form IHT 400) has to be filed but in other cases there is a shorter form IHT 205 which can be used.

If an estate has no IHT to pay, it will usually be an 'excepted estate' and the short form sufficient. However, this is not always the case as HM Revenue & Customs (HMRC) want to monitor reliefs/exemptions being claimed. There can therefore be some estates that do not have an IHT liability that are excluded from being classed as an excepted estate, and a full IHT account (form IHT400) will still be required.

IHT is usually only due if the estate, including any assets held in trust and gifts made within seven years of death, is valued over the IHT nil-rate band (£325,000 for the tax years 2010/11 through to 2014/15).

During 2010 there was a consultation process covering:

how to incorporate the availability from 2007 of the transferrable portion of unused nil-rate band from the estate of a pre-deceasing spouse or civil partner,
tightening up the position where the gross value of the estate less liabilities was under £1 million, and
HMRC receiving details where the 'normal gifts out of income' IHT exemption was in point.

When is an estate an excepted estate?

For deaths after 1 September 2006, an estate will generally be an 'excepted estate' if: it is a low value estate - valued at under the IHT nil-rate band of £325,000 (but subject to some conditions);
it is an exempt estate - the deceased person left everything (or everything over and above the IHT nil-rate band) to a spouse or civil partner living in the UK or to a 'qualifying' charity (and the estate is valued at under £1 million); or
the deceased person was a 'foreign domiciliary' - they lived permanently abroad and died abroad and the value of their UK assets is under £150,000.

For one of the above types the form IHT 205 Return of Estate Information (or form C5 in Scotland) may be all that will be needed as part of the probate process.

However, a check must be made that the estate does not fail any of the conditions that would disqualify it from being excepted

When is an estate not an excepted estate?

An estate will not be an excepted estate if any of the following is true about the deceased:

they left an estate worth more than the IHT nil-rate band (£325,000 for the tax years 2010/11 through to 2014/15) or an estate worth more than £1 million to a spouse, civil partner or 'qualifying' charity,
they had a permanent home outside the UK when they died but had a permanent home within the UK at one time,
they had assets in a trust valued at more than £150,000,
they had assets worth more than £100,000 outside the UK,
they made gifts within seven years before they died and the value of the gifts was more than £150,000 after deducting any IHT exemptions,
they made gifts into trusts,
they continued to benefit from a gift they had made to someone else, such as their house or car (known as a 'gift with reservation of benefit'),
they had a life insurance policy that paid out to someone else - but not to their spouse or civil partner - and they had also bought an annuity,
they had a personal pension from which they had not taken their full retirement benefits, and when they were terminally ill or in poor health they changed the death benefits payable on it to increase the value of the lump sum,
they had, or were the beneficiary of, an 'Alternatively Secured Pension' or unsecured pension,
they elected that property that they had given away should be part of their estate for IHT, rather than pay a 'pre-owned asset' charge, or
they were regarded as 'deemed domicile' in the UK - this usually applies if the deceased was not born in the UK but had lived here for the last 17 years, or was born in the UK but died within three years of emigrating.

In any of these cases, the estate is not an excepted estate and a full IHT account (form IHT400) completed.

Amendments to the Excepted Estates Regulations

Amendments to the Excepted Estate Regulations apply from 1 March 2011:

allowing certain estates benefiting from a transfer of nil-rate band to use the excepted estate procedure (for deaths on or after 6 April 2010)
ensure that the 'exempt' class of excepted estate applies only where there are exempt transfers by virtue of a spouse, civil partner or charity transfer (for deaths on or after 1 March 2011)
require transfers within seven years of death in excess of £3,000 in a tax year that qualify for exemption as normal expenditure out of income to be taken into account when determining eligibility as an excepted estate (this will apply to deaths on or after 1 March 2011)

Background to the amendments

The Inheritance Tax (Delivery of Accounts) (Excepted Estates) (Amendment) Regulations 2011 (Statutory Instrument 2011/214) amended the excepted estates regulations.

Benefiting from a transfer of nil-rate band

Since 2007, where a deceased person's IHT nil-rate band is not fully used, the unused proportion can be claimed in respect of a surviving spouse or civil partner and used against the survivor's estate when they die. There are therefore a number of estates in excess of the nil-rate band filing full IHT accounts having no IHT to pay as the nil-rate band applicable was proportionally increased due to the unused part flowing through from the predeceasing spouse/civil partner.

The instrument prescribes that an estate benefiting from transferred unused nil-rate band will benefit from the transferred IHT threshold for the purposes of the Excepted Estates Regulations where all of the first deceased's nil-rate band was unused, for example where the whole estate was transferred exempt from IHT to a spouse or civil partner.

This change is retrospective and applies to deaths on or after 6 April 2010.

It had been hoped that there would have been an allowance, for still treating as excepted, for estates that were within the uplifted nil-rate band where not all of the first deceased's estate was unused. For instance, if on the first death everything is passed to a spouse subject to a bequest of a £100 to a godchild, the availability of the 99.9% unused nil-rate band will be ignored when considering the status and filing requirements of the estate of the surviving spouse/civil partner.

Exempt transfers by virtue of a spouse, civil partner or charity transfer

The prescribed circumstances allow estates of up to £1m in value to qualify as an excepted estate where there is no IHT to pay because the assets passing under the estate are exempt from IHT by virtue of passing either to a surviving spouse/civil partner, or to charity. However, an error in the regulations prior to the amendment meant that the personal representatives of some estates where these exemptions do not apply could nevertheless submit an excepted estate return. The instrument removes this unintended effect. For deaths before 1 March 2011 estates with a value falling in between the nil-rate band and £1 million would be treated as excepted if the liabilities of the estate took the net value below the nil-rate band irrespective of part passing to a surviving spouse, civil partner or charity.

For deaths from 1 March 2011 at least part of the estate must pass to a surviving spouse, civil partner or charity for inclusion under this rule.

Normal expenditure out of income to be taken into account

The controversial change concerns the treatment in respect of the exemption from IHT for transfers made as part of 'normal expenditure out of the income' of the transferor.

As a reminder, gifts are exempt from inheritance tax where it can be demonstrated that they are part of a regular pattern of giving, and are made out of surplus income, as opposed to eroding capital.

Up until the change, any dispositions of value considered as falling within the 'normal expenditure out of the income' exemption were ignored when considering the value of an estate at the time of death and the value of transfers within the previous seven years. HMRC has stated that, in its experience, this exemption can be used inappropriately with the consequence that IHT is not paid when it is due.

In order to enable HMRC to properly scrutinise the relief, where in any tax year in the seven years prior to death, a person has transferred over £3,000 that is considered to be exempt as part of normal expenditure out of their income, the amount transferred will nevertheless be included in the value of that person's estate, for deaths from 1 March 2011, for the purpose of determining whether the personal representatives are excused from the requirement to deliver an IHT account to HMRC, even though the transfer itself may qualify for the exemption.

For example, take the case of someone who had been paying over the previous seven years a total of £1,000 per month to their grandchildren and dies with net assets of £300,000.

On death, their estate is under the £325,000 nil-rate band. For deaths prior to 1 March 2011 the amount of the amount considered to be covered by the 'normal expenditure out of the income' would have been ignored and only a short IHT return would have been necessary. As this gives no details of the amount being considered covered by this exemption HMRC would not have been aware of the £84,000 given away over the previous seven years and therefore not have been able to ask any questions about it.

For deaths on or after 1 March 2011 £9,000 of the £12,000 given each year would be treated as 'chargeable transfers', giving a combined figure of £363,000 to be compared against the nil-rate band with the result that a full account would need to be filed. This full account would show the total of the gifts out of income and the exemption being applied. HMRC would then be in a position to check that the exemption had been applied correctly.

The exemption itself is not being attacked or being capped at £3,000 per annum. It is just that the amount of such gifts has to be taken into account when deciding which set of forms needs to be completed.

For the wealthier clients, where the size and nature of the estate on death meant a form IHT 400 would have been required, there is no change. There will now be group of estates in the middle where HMRC was not getting full details where information will be now need to be reported so that HMRC have the chance to check.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

UK: Excepted Estates And The Changes From 1 March 2011