Finance Act 2012 introduced a significant rule reducing from 40% to 36% the rate of Inheritance Tax (IHT) where at least 10% of the estate is left to UK registered charities. What is easily forgotten is that this is the ‘net estate’, that is after deducting the general nil-rate band of £325,000 and, where applicable, the residence nil-rate band of £175,000 – quite apart from any available exemptions and reliefs.
If you are charitably minded, have you given thought to how you can use the various exemptions and reliefs from IHT and Income Tax, for the benefit both of your chosen charities and of your family – even if HMRC might lose out?
Imagine a widow, Kate, who dies with an estate of £1,000,000, of which she leaves £50,000 to a particular charity and residue to her two children. She has her own £325,000 nil-rate band intact, along with the £175,000 residence nil-rate band, but none inherited from her late husband. Deducting the total nil-rate band from her estate together with the charitable legacy produces £450,000, on which IHT at 40% is £180,000.
Adding the charitable gift of £50,000 to the net estate makes £550,000, of which 10% is £55,000, so the case doesn’t qualify for FA 2012 relief and the £180,000 IHT bill remains. However, if the two children were happy to forgo £10,000 of their inheritance between them and to vary the Will so that the charitable gift becomes £60,000, the total of the net estate and the charitable gift is £560,000, of which £60,000 is 10%. Accordingly, IHT on the reduced £440,000 is charged at 36% to produce a tax bill of £158,400 – instead of £176,000 (had IHT been charged at 40%).
So, while HMRC loses out to the tune of £17,600, the charity gets another £10,000 and the two children receive between them an extra £7,600 (the saving in IHT less the increased charitable gift). Moreover, under Gift Aid, assuming that each of the donors qualifies in the tax year as having paid Income Tax or Capital Gains Tax at least equal to the Gift Aid Relief on all charitable gifts, the charity receives a further £2,500 and the children the potential of Additional Rate Relief of 25% of £12,500, viz £1,562.50 each (both paying Income Tax at a marginal rate of 45%).
And then you see how the whole thing can be made even so much better, apart from HMRC’s point of view. Suppose the whole charitable gift of £60,000 was not left in the Will, but made by Deed of Variation under Inheritance Tax Act 1984, section 142. Then not only is the same IHT result obtained, but also the charity gets £15,000 under Gift Aid on top of the £60,000 gift and the children’s total Additional Rate Income Tax Relief is increased accordingly (to 25% of £75,000 or £9,375 each).
