A group of high-profile MPs led by the former Chancellor of the Exchequer Nadhim Zahawi have called for inheritance tax to be abolished. Dramatically, Zahawi said inheritance tax is “morally wrong” and the “spectre that haunts us alongside death.”
Despite being a popular decision, abolition of the tax is unlikely, particularly given the financial constraints facing government. It may, however, open the door to reform. It would be long overdue and welcomed.
Inheritance tax (IHT) is a deeply unpopular tax despite affecting just a small group of the population. Just 4% of deaths trigger an IHT liability. It is, by comparison to income tax or corporation tax, expensive administer, less automated, often requiring papers to be reviewed manually to check valuations. In the 2021/22 tax year, it raised just £6.1 billion of the total £157.5 billion in UK tax receipts.
Inheritance tax is payable on individual estates valued over £325,000 – the nil rate band – with the spousal exemption increasing that threshold to £650,000. An additional £175,000 is available under the residential nil rate band, raising the IHT threshold to £1m for married couples passing property to their children. Inheritance tax is then charged at 40% on the remaining estate.
Despite numerous promises from the Conservative Party in its election manifestos, the tax has remained unchanged. The nil-rate band has sat at £325,000 since 2008 and, remarkably, the annual limit on gifts has remained at £3,000 since 1981. Back then, the average house in the UK could be purchased for £23,000!
As house prices have increased dramatically, more so in London and the South East, and remain the most valuable asset most own, more and more people are drawn into the IHT net.
Where those with a diverse asset portfolio and considerable wealth can undertake perfectly legitimate steps to limit their exposure to IHT, those whose wealth is tied primarily to their home find they have little options open to them. It is why IHT is sometimes called a voluntary tax.
Scrapping IHT would undoubtedly be popular with the electorate, irrespective of whether or not they will fall into its net; the principle of ‘double taxation – taxed on death after a lifetime of paying income tax – does not sit comfortably with those who are financial prudent. Abolition is, however, unlikely.
What might reform of IHT look like? Three areas are ripe for change: the nil rate band, the headline rate, and gifting limits.
Compared to the US, where its estate tax exemption currently stands at US$12 million (and US$24 million for married couples), the UK nil rate band of £325,000 looks mean.
Increasing the nil rate band to £500,000 (and £1 million for married couples) would be relatively straightforward. It should be accompanied by the removal entirely of the residential nil rate band, that is complex and applies only in certain circumstances. It would extend the relief to unmarried and childless married couples who cannot currently benefit.
Further, the Government should look at the headline rate; at 40% it is currently one of the highest inheritance tax rates in the world. The suggestion from Dan Neidle, a former tax lawyer at the world’s largest law firm and founder of the think tank Tax Policy Associates, of a flat 25% or even a 20% rate alongside the removal of many of the exemptions available would be sensible.
Finally, reviewing and making more generous the gifting rules, bringing them in line with the cost of living in 2023 would be welcomed.
There is, of course, always a risk that in tinkering with the rules the Government makes the IHT regime more complex. And that should be avoided at all costs.
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The above is accurate as at 08 June 2023. The information above may be subject to change.
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.