IHT liability calculation

[UnclePhilip]

hiriskpaul wrote:

I was speaking to a friend yesterday who thinks most of her inheritance from her mother will be swallowed by inheritance tax. I think she is wrong. The situation is that her mother’s house is jointly owned by my friend’s sister (Joint tenants, half the house gifted to sister about 20 years ago) and her mother has savings and investments of about £600k. The Will is straightforward and divides the estate equally between the 2 sisters. There is nothing in the Will about inheritance tax.

On her mother’s death, the house will pass to her sister by survivorship. She is not entirely happy about this, but resigned to it. The house is worth about £2.8m and the total nil rate and resident nil rate bands are £1m, so IHT is payable on £1m (£1400k house plus £600k savings minus £1000k NRB/RNRB). IHT at 40% is £400k. Who pays the IHT?

My friend thinks that the residual estate is liable for the IHT, which comes out of the savings and investments, leaving just £200k to divide between the sisters. I think she is wrong and that her sister is liable for a higher proportion of the IHT due to the house being passed by survivorship. Pre-IHT, her sister inherits £1.7m, my friend £300k, so her sister should bear the cost of 1.7/2.0 of the IHT, which works out at £340k and my friend should bear 0.3/2.0 of the IHT, £60k.

Who is right? Or are neither of us right? Or is it nuanced?

It is indeed nuanced.

Analysing the issues:

The house is worth about £2.8m and the total nil rate and resident nil rate bands are £1m, so IHT is payable on £1m (£1400k house plus £600k savings minus £1000k NRB/RNRB). IHT at 40% is £400k.

(I assume the reference suggesting 'total nil rate and resident nil rate bands are £1m' is because the mother's spouse died leaving their entire estate to the mother. If this is not the case, the total available NRB indicated below will be lower)

If the sister owning the joint interest does not occupy the property with her mother, the mother's original gift is likely to be treated as a 'gift with reservation of benefit' (GWR*). See HMRC inheritance tax manual at IHTM44331 et seq.
https://www.gov.uk/hmrc-internal-manual ... /ihtm14331

This would mean that the entire (undiscounted) value of the property would be included in the mother's estate for inheritance tax purposes. This in turn would mean that, as her total estate is over £2.35 million, she will not qualify for the Residence Nil Rate Band, so her total NRB would be only £650k. On a total estate of £3.4m (£2.8m house, plus £0.6m investments), this would mean an IHT liability of £1.1m.

Even if the sister occupies the house with her mother, the original gift could still be treated as a GWR unless strict conditions regarding, inter alia sharing of property and household costs, have been met.

*If the gift did not constitute a GWR, it may alternatively have been caught by the Pre Owned Asset Tax (POAT) rules. The POAT was introduced with effect from the tax year 2005-06. See HMRC inheritance tax manual at IHTM44001 et seq:
https://www.gov.uk/hmrc-internal-manual ... /ihtm44001

Who pays the IHT? My friend thinks that the residual estate is liable for the IHT, which comes out of the savings and investments

Your friend is correct - IHT is a liability of the Executor(s), initially payable out of the estate assets (in this case the £600k of investments, meaning your friend would inherit nothing). If the estate assets are insufficient, any excess liability falls on the recipient of the gifted asset treated for IHT purposes as part of the estate (the sister owning the property).

HMRC would only be interested in collecting the tax; they are not normally concerned with any unfairness this creates between beneficiaries under the will.

To enable your friend to receive at least something from the estate, she could suggest that the mother severs the joint tenancy to create a tenancy in common. I believe this merely involves her writing to the other joint tenant, giving notice that she wishes to hold her interest as a tenant in common. The other joint tenant’s agreement is not required. Following severance, the principle of survivorship will then no longer apply to the mother's interest in the property. (NB No tax implications arise from the severance itself).

The mother perhaps would accept that the dramatic increase in property value has created iniquity as between the previous gifts to each sister. In any event, it is worth explaining to her that her intention to treat the sisters equally in her Will are currently negated by the issues noted above.

As the share would then form part of her estate assets for probate purposes as well as for IHT, it can be bequeathed in accordance with her Will. Although this does not save tax, it would mean the estate assets would be £2m which, after payment of £1.1 million IHT, would leave £900k divisible between the sisters (£450k each).

How the 'property owning' sister funds the excess IHT liability of £500k (the £600k investments would, as indicated above, be used to part pay the £1.1m liability) and the £450k inheritance due to her sister would be an issue. It is likely the property would need to be sold (note that the sister's CGT base cost will be the value at the time of the original gift, and this is unaffected by the IHT issues above).

If the sister actually occupies the property with her mother AND the gift is not otherwise caught by the GWR and POAT rules, the valuation discount that would be applied to the mother’s half share for inheritance tax purposes should be 15%. Her taxable estate would then be £1.79m, less £1m NRB/RNRB (as total IHT estate value now less than £2m), suggesting an IHT liability of £316k.

Eisman

Having recently spent an inordinate amount of time and brain energy immersing myself in the labyrinthine world of IHT, I just want to gasp in admiration at the sheer brilliance of this post Eisman.

Thank you!

[hiriskpaul]

hiriskpaul wrote:

I was speaking to a friend yesterday who thinks most of her inheritance from her mother will be swallowed by inheritance tax. I think she is wrong. The situation is that her mother’s house is jointly owned by my friend’s sister (Joint tenants, half the house gifted to sister about 20 years ago) and her mother has savings and investments of about £600k. The Will is straightforward and divides the estate equally between the 2 sisters. There is nothing in the Will about inheritance tax.

On her mother’s death, the house will pass to her sister by survivorship. She is not entirely happy about this, but resigned to it. The house is worth about £2.8m and the total nil rate and resident nil rate bands are £1m, so IHT is payable on £1m (£1400k house plus £600k savings minus £1000k NRB/RNRB). IHT at 40% is £400k. Who pays the IHT?

My friend thinks that the residual estate is liable for the IHT, which comes out of the savings and investments, leaving just £200k to divide between the sisters. I think she is wrong and that her sister is liable for a higher proportion of the IHT due to the house being passed by survivorship. Pre-IHT, her sister inherits £1.7m, my friend £300k, so her sister should bear the cost of 1.7/2.0 of the IHT, which works out at £340k and my friend should bear 0.3/2.0 of the IHT, £60k.

Who is right? Or are neither of us right? Or is it nuanced?

It is indeed nuanced.

Analysing the issues:

The house is worth about £2.8m and the total nil rate and resident nil rate bands are £1m, so IHT is payable on £1m (£1400k house plus £600k savings minus £1000k NRB/RNRB). IHT at 40% is £400k.

(I assume the reference suggesting 'total nil rate and resident nil rate bands are £1m' is because the mother's spouse died leaving their entire estate to the mother. If this is not the case, the total available NRB indicated below will be lower)

If the sister owning the joint interest does not occupy the property with her mother, the mother's original gift is likely to be treated as a 'gift with reservation of benefit' (GWR*). See HMRC inheritance tax manual at IHTM44331 et seq.
https://www.gov.uk/hmrc-internal-manual ... /ihtm14331

This would mean that the entire (undiscounted) value of the property would be included in the mother's estate for inheritance tax purposes. This in turn would mean that, as her total estate is over £2.35 million, she will not qualify for the Residence Nil Rate Band, so her total NRB would be only £650k. On a total estate of £3.4m (£2.8m house, plus £0.6m investments), this would mean an IHT liability of £1.1m.

Even if the sister occupies the house with her mother, the original gift could still be treated as a GWR unless strict conditions regarding, inter alia sharing of property and household costs, have been met.

*If the gift did not constitute a GWR, it may alternatively have been caught by the Pre Owned Asset Tax (POAT) rules. The POAT was introduced with effect from the tax year 2005-06. See HMRC inheritance tax manual at IHTM44001 et seq:
https://www.gov.uk/hmrc-internal-manual ... /ihtm44001

Who pays the IHT? My friend thinks that the residual estate is liable for the IHT, which comes out of the savings and investments

Your friend is correct - IHT is a liability of the Executor(s), initially payable out of the estate assets (in this case the £600k of investments, meaning your friend would inherit nothing). If the estate assets are insufficient, any excess liability falls on the recipient of the gifted asset treated for IHT purposes as part of the estate (the sister owning the property).

HMRC would only be interested in collecting the tax; they are not normally concerned with any unfairness this creates between beneficiaries under the will.

To enable your friend to receive at least something from the estate, she could suggest that the mother severs the joint tenancy to create a tenancy in common. I believe this merely involves her writing to the other joint tenant, giving notice that she wishes to hold her interest as a tenant in common. The other joint tenant’s agreement is not required. Following severance, the principle of survivorship will then no longer apply to the mother's interest in the property. (NB No tax implications arise from the severance itself).

The mother perhaps would accept that the dramatic increase in property value has created iniquity as between the previous gifts to each sister. In any event, it is worth explaining to her that her intention to treat the sisters equally in her Will are currently negated by the issues noted above.

As the share would then form part of her estate assets for probate purposes as well as for IHT, it can be bequeathed in accordance with her Will. Although this does not save tax, it would mean the estate assets would be £2m which, after payment of £1.1 million IHT, would leave £900k divisible between the sisters (£450k each).

How the 'property owning' sister funds the excess IHT liability of £500k (the £600k investments would, as indicated above, be used to part pay the £1.1m liability) and the £450k inheritance due to her sister would be an issue. It is likely the property would need to be sold (note that the sister's CGT base cost will be the value at the time of the original gift, and this is unaffected by the IHT issues above).

If the sister actually occupies the property with her mother AND the gift is not otherwise caught by the GWR and POAT rules, the valuation discount that would be applied to the mother’s half share for inheritance tax purposes should be 15%. Her taxable estate would then be £1.79m, less £1m NRB/RNRB (as total IHT estate value now less than £2m), suggesting an IHT liability of £316k.

Eisman

Thank you for such a comprehensive reply. As you say, nuanced. Very good point about the valuation discount on jointly held property, which will certainly prove useful.

I have indeed included their father's NRB and RNRB in the £1m total nil rate. The father's NRB was not used and RNRB was not even available at the time he died.

On GWR/POAT, I think they are in the clear. The sister given half the house has always lived there and paid half the bills since her father died. Certainly something for further consideration though.

My friend is not really complaining about the fact that her sister is due to inherit the family home. She has done well out of her own home, quite probably helped by money given to her by her mother when her sister was given half the house and promised the rest when their mother died. What she doesn't like is the prospect of having to bear a disproportionate share of the inheritance tax bill.

Your friend is correct - IHT is a liability of the Executor(s), initially payable out of the estate assets (in this case the £600k of investments, meaning your friend would inherit nothing). If the estate assets are insufficient, any excess liability falls on the recipient of the gifted asset treated for IHT purposes as part of the estate (the sister owning the property).

I have been doing some more digging into the HMRC internal manual on this and your description on the way that the burden of IHT is shared seems to be at odds with some of the example calculations. For example https://www.gov.uk/hmrc-internal-manual ... /ihtm31035

Calculate the tax on Entries A and B:
Entry A
(£750,000 – £300,000) × 40% = £180,000

This is then apportioned between:

The personal property (not paid by instalments) £250,000 × £180,000 tax ÷ £750,000 = £60,000
The freehold property (paid by instalments) £500,000 × £180,000 tax ÷ £750,000 = £120,000

So in this example a higher amount of tax is apportioned to the freehold property than to the personal assets. Which has been my view (possibly from a previous reading of the manual pages) and Scrumpyjack's. If the probate value of mother's share of the house (after discount) was £1.4m, personal assets £600k, then following the HMRC example, there would be £2m of assets with IHT due of

(£2,000,000 – £1,000,000) × 40% = £400,000

This is then apportioned between:

The personal property £600,000 x £400,000 tax / £2m = £120,000
The freehold property £1,400,000 x £400,000 tax / £2m = £280,000

The freehold property goes entirely to one sister along with half the personal possessions, so bears £60k + £280k = £340k of the IHT. The other sister inherits half the personal property and so bears only £60k of the IHT.

I feel that the HMRC must mandate a correct way to do the apportionment. Doing it any other way could lead to PETs between beneficiaries.

[scrumpyjack]

I suppose looking at it on a practical level, if both sisters are executors, then the sister who does not get the house can refuse to release estate funds to pay the IHT apportioned to the house and elect for payment of the IHT apportioned to the property in 10 instalments. Then the full payment of IHT is not needed before probate is granted. In this way that sister may have some leverage to ensure that the estate is dealt with equitably? She will need to get in quick and notify promptly the banks and holders of the other assets that she is an executor!

[hiriskpaul]

It seems to me that the mother firstly needs competent advice regarding her tax situation, and secondly to make a new Will as a matter of priority, otherwise this grossly unfair division will almost inevitably cause a serious, and probably lifelong rift between the sisters.

Yes, I certainly think a discussion should be had, possibly leading to a new Will and maybe severence of the joint tenancy. As I said above, it was always intended that one sister should inherit the house. I don't know whether that is grossly unfair or not as I don't know what was given to my friend at the time the joint tenancy was set up. I do know that my friend was happy with the arrangement at the time, so can only assume the gift was substantial or that she felt that her sister was more deserving for some reason.

I find it odd that such a simple scenario, jointly held house going to the other joint holder plus equally shared residuary estate, should lead to such uncertainty as to how the IHT should be apportioned! Do you have a view on how this should be done?

One other curious thought - if the house was held 50/50 as tenants in common, with the mother's share passed to the sister as a specific legacy under the Will with the residuary estate shared equally as now, would the IHT be apportioned any differently? It would be distinctly odd if that were the case.

[eisman]

hiriskpaul wrote

I have been doing some more digging into the HMRC internal manual on this and your description on the way that the burden of IHT is shared seems to be at odds with some of the example calculations.

If the probate value of mother's share of the house (after discount) was £1.4m, personal assets £600k, then following the HMRC example, there would be £2m of assets with IHT due of

(£2,000,000 – £1,000,000) × 40% = £400,000

This is then apportioned between:

The personal property £600,000 x £400,000 tax / £2m = £120,000
The freehold property £1,400,000 x £400,000 tax / £2m = £280,000

The freehold property goes entirely to one sister along with half the personal possessions, so bears £60k + £280k = £340k of the IHT. The other sister inherits half the personal property and so bears only £60k of the IHT.

I feel that the HMRC must mandate a correct way to do the apportionment.

Your detailed research does you credit. I had forgotten about the 10 year payment option for property, but it is several years since I've had to deal with such matters. Your calculations appear to indicate the likely apportionment of the tax liability.

HMRC will indeed issue calculations of the inheritance tax due, in accordance with the IHT return submitted following the death of the mother. It is important that a claim is made in the appropriate box on Form IHT400 to enable that proportion of the tax to be payable over 10 years.

Note that interest is chargeable on the outstanding tax, and the full amount of tax becomes payable if the property is sold.

And your final point

One other curious thought - if the house was held 50/50 as tenants in common, with the mother's share passed to the sister as a specific legacy under the Will with the residuary estate shared equally as now, would the IHT be apportioned any differently?

I don't believe there is any difference for inheritance tax purposes between a 50/50 share held as joint tenants as opposed to tenancy in common, as the inheritance tax consequences are identical. The main difference is the latter constitutes an asset for Probate purposes, passing under the Will.

Eisman