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Case Study: Navigating Inheritance Tax Pitfalls – A Costly Lesson Learned

Tax

Introduction

In this scenario a UK resident individual, let’s call him John who was in his early 70’s and a widower, found himself facing a significant Inheritance Tax bill. Having a UK property worth £500,000 and investments amounting to £600,000, John contemplated a strategy to mitigate the inheritance tax (IHT) impact without seeking professional advice.

The Risky Plan

In an attempt to sidestep inheritance tax, John considered selling his house to his son, who resides in Guernsey, a country with no inheritance tax. The plan involved his son, (who had recently sold his business for several million pounds) purchasing the property, and John sending the proceeds back to him as a gift but with John still living in the house. The goal was for John to live for another seven years, hoping to avoid hefty inheritance tax charges.

Professional Analysis

However, our team of experts quickly pointed out the flaws in this plan. The proposed scheme of “selling” the house to the son, only to later gift the proceeds  back would not be acceptable to HM Revenue and Customs. The Gift with Reservation of Benefit (GWR) rules state that if an asset is given away but the donor continues to benefit from it, it will still be taxed as part of John’s estate for IHT purposes.

Additionally, the Pre-Owned Assets Tax (POAT) which introduced an income tax charge on benefits received by the former owners of property could also have applied however a way around this is to pay a commercial rent for continuing to live in the house you have gifted.

Essentially, the plan would have been ineffective, and the value of the property would remain in John’s estate for inheritance tax purposes.

Additionally, the son’s residence in Guernsey did not exempt the property from UK-based IHT (since it was UK sited), potentially leading to complexities in the future.

Professional Advice

What if John had sought professional advice from Dixcart UK before embarking on this risky endeavour? Let’s walk through it.

  • Scenario Planning:

Dixcart UK, with its team of accountants, tax advisers, and lawyers, could have guided John through a comprehensive scenario analysis. By understanding John’s financial situation, Dixcart professionals could have illustrated the potential outcomes of various strategies, highlighting the risks and benefits associated with each.

  • Strategic Gifting:

Instead of opting for a convoluted plan that involved selling the house and repaying the proceeds, Dixcart could have advised John on more straightforward and legally sound methods of mitigating inheritance tax. One such approach might involve strategic gifting within the allowable limits set by legislation or making Potentially Exempt Transfers (PET’s) of the financial assets owned by John.  A gift of cash for example would be a PET and so if John was to survive for 7 years from making the gift then the PET escapes IHT altogether. PETs made out of the 7 year period will never be brought into the IHT calculation.  Gifts made out of excess income can also be an effective strategy.

  • Utilising Tax Allowances

Dixcart UK could have helped John leverage his nil-rate band (£325,000), his late wife’s nil-rate band (potentially up to £325,000), along with his own residence nil-rate band (£175,000) and his late wife’s (£175,000), making a total of £1 million in allowances. Exploring options like gifting a portion of his investments within this allowance could have been a more tax-efficient and transparent strategy.

  • Long-Term Planning:

Moreover, Dixcart UK could have assisted John in developing a long-term inheritance tax mitigation plan. By understanding John’s financial goals and family situation, the professionals could have provided guidance on how to structure his estate in a tax-efficient manner, ensuring a smoother transition of assets to the next generation.

Conclusion

John’s case serves as a powerful illustration of the pivotal role professional advice plays in navigating complex financial decisions. Seeking guidance from Dixcart UK could have potentially saved John from the complications and financial pitfalls he faced. The case underscores the importance of consulting professionals in accounting, tax advisory, and legal services to ensure individuals make informed decisions and avoid unnecessary financial burdens.

By exploring the hypothetical scenario where John had come to Dixcart UK first, we emphasise the proactive role professionals can play in securing a sound financial future and mitigating risks associated with inheritance tax. This case study aims to reinforce the value of expert consultation and strategic planning in safeguarding individuals from unforeseen financial consequences.

Get in Touch

If you have any questions regarding the tax implication and inheritance planning, please get in touch at: hello@dixcartuk.com


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The data contained within this document is for general information only. No responsibility can be accepted for inaccuracies. Readers are also advised that the law and practice may change from time to time. This document is provided for information purposes only and does not constitute accounting, legal or tax advice. Professional advice should be obtained before taking or refraining from any action as a result of the contents of this document.


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