BKL tax adviser Terry Jordan, co-writing with private client solicitor Gemma Townsend, examines the tax requirements and associated implications when a client dies. This article was first published by Taxation magazine and is also available on the Taxation website.
KEY POINTS
- The government’s “tell us once” service can help in the administrative obligations when a person dies.
- Although there is an acquisition value uplift on death, executors may be liable to capital gains tax on subsequent disposals.
- Note that the executor’s capital losses cannot be transferred to beneficiaries.
- Unused inheritance tax nil-rate band can be transferred between spouses and civil partners.
- An inheritance tax account must be delivered within 12 months of death.
Whenever we talk to clients about their tax affairs and future tax planning, the conversation very often turns to the inevitability of death and the difficulty in avoiding the burden of taxes. The rather fatalistic and sardonic words of Benjamin Franklin in a letter to Jean-Baptiste Leroy in 1789 still ring true: “Nothing can be said to be certain, except death and taxes.” It’s a statement we hear only too often in our business.
When a client dies, their “estate” (as defined by IHTA 1984, s 5) must pay any taxes due before it can be distributed. Usually, when the beneficiaries inherit a legacy there is no tax to be paid by them immediately; however, there may be some liability to pay later.
Income tax
On the death of a client, it is important that HMRC are informed, to enable them to calculate whether the correct amount of tax has been paid by the deceased up to the date of death. If too little or too much tax has been paid, the department will make an adjustment which may result in the estate owing tax or receiving a rebate.
The “tell us once” service can assist here. This allows the death to be reported simultaneously to most government departments. When a death has been registered, the registrar will provide a reference number. The representative can then input this information [1] and HMRC and the Department for Works and Pensions (DWP) should automatically contact the executor about the deceased’s tax, benefits and entitlements. Unfortunately, this service is not yet available in Northern Ireland.
If the deceased usually completed a self-assessment tax return, or their tax affairs in the year of death were at all complex, a tax return for the period from 6 April to the date of death will probably need to be completed.
The deceased’s estate may continue to receive income from rent, savings or investments and the income tax must be paid on this. Tax is usually deducted at source on any interest arising from UK savings accounts and dividends from UK shareholdings and no further tax is due on these sources because an estate will not be subject to tax at the higher rates. However, it is always best to check with the provider directly because not all savings products have tax deducted at source – some National Savings and Investments (NS&I) products, for example. If income has not had tax deducted at source – such as rent, business profits, overseas income and income from foreign shareholdings – the personal representatives must complete a tax return from the date of death to the following 5 April and for any further tax years during the period of administration.
It is proposed that, from 6 April 2016, dividends will no longer carry an associated tax credit. There is to be a £5,000 annual exemption from tax on dividends, but it is not yet clear how this will apply to estates.
There is no legal obligation for personal representatives to provide beneficiaries with an R185 “statement of income from estate” certificate as evidence of income received and tax deducted from the estate of a deceased person. However, it is useful and is the most convenient way for the personal representatives to fulfil their obligation to account to the beneficiaries. A charity and certain individuals will require an R185 to recover tax that has already been deducted at source. This applies only to income received in the period of administration because capital receipts are normally free from tax for the recipient.
Capital gains tax
Death is not a chargeable event for capital gains tax purposes (TCGA 1992, s 62). Any assets held by the deceased at the date of death will therefore benefit from a tax-free uplift in value to the date of death, eliminating any taxable gain.
A beneficiary who inherits a chargeable asset acquires it at its probate value as “legatee”. However, the estate will have to pay capital gains tax if the personal representatives sell an asset and its value has risen between the dates of death and sale. The personal representatives do have a tax-free allowance (£11,100 for 2015/16) for the tax year of death and the next two tax years, so not all gains will result in a tax charge. A loss realised by the personal representatives can be offset against any gains they make, but it cannot be transferred to the beneficiary.
Should chargeable gains exceed the exemption, capital gains tax is charged at 28% currently. Usually, it should be possible to avoid such a liability in the administration period because the acquisition cost will be the probate value and the scope for significant appreciation in value is limited. Further, assets can be transferred directly into the ownership of those who inherit the estate, without a disposal occurring (TCGA 1992, s 62(4)).
If the deceased held a qualifying interest in possession in a trust at the date of death, the fund will also benefit from the capital gains tax-free uplift; the remainder men in effect acquiring chargeable assets at their probate value. Note that when a beneficiary of a discretionary trust, including post-21 March 2006 “non-estate” trusts, dies, there is no benefit from the tax-free uplift because there is no qualifying interest in the trust fund.
Inheritance tax
Inheritance tax is, at the time of writing, payable on estates worth more than £325,000 (and is fixed at this level until 5 April 2021). Married couples or civil partners can benefit from a “transferable nil-rate band” (IHTA 1984, s 8A to s 8C, inserted by FA 2008, s 10) so their combined estates can be worth up to £650,000 before this tax is payable. However, an inheritance tax form must be completed in all matters where the personal representatives are applying for a grant of representation. This is to establish the value of the estate so that HMRC can ascertain what tax, if any, is due and what exemptions are available.
A beneficiary who has obtained a legacy from an estate will pay no tax on receipt. However, the cash, investments or other property belong to them from the date of distribution and they will be liable for tax on any subsequent income or gains arising in the normal way (IHTA 1984, s 4).
If an asset has been transferred to a beneficiary, capital gains tax may be payable when it is sold. The tax will be payable only on the increase in value between the date of death and the date the asset is sold by the beneficiary. Of course, the annual exemption must be borne in mind when calculating the tax payable at this stage.
Inheritance tax on death is charged at 40%. The deceased’s estate could benefit from a reduction in the rate payable if charitable bequests are made. If at least 10% of the net estate is left to charity, a 36% rate of inheritance tax is payable on the remainder of the estate above the nil-rate threshold.
Transferring ISA benefits
For deaths on or after 3 December 2014, the tax-free status of the deceased’s individual savings accounts (ISAs) can be passed to a surviving spouse or civil partner. This is done by giving the surviving spouse or civil partner an additional, one-off ISA allowance equal to the value of the deceased’s ISA holdings.
AIM stocks can now be held in ISAs and purchased free of stamp duty and some benefit from 100% business property relief if they are owned for two years. Remember that trading companies benefit from business property relief and a spouse inherits the period of ownership of a deceased spouse.
Probate and administration
We have been talking about the tax that is payable by the personal representatives of a deceased’s estate, but who are the personal representatives and where does their authority to act come from?
If the deceased left a will, codicil or possibly even a letter of wishes, these documents should specify how the estate is to be distributed. The “estate” is all of the money, possessions and property in the deceased’s possession at their death. An executor is a personal representative who was named in the will and it is the executor who takes out the grant of probate.
If there is no will, or if the will is invalid or fails to deal with the entire estate, the deceased is said to have died intestate or partly intestate. The intestacy rules are contained in the Administration of Estates Act 1925, Parts 3 and 4 and the most recent changes in the Inheritance and Trustees’ Powers Act 2014. In this case, the administrator is the personal representative of the deceased’s estate. The entitlement to apply for the grant of letters of administration usually follows those who are entitled and is set out by statute (see the Non Contentious Probate Rules 1987, rule 20).
In both instances, a grant must be obtained. This acts as the formal authority of the personal representatives to deal with the deceased’s estate, encash any accounts and transfer property and shares accordingly. Note that one but not more than four persons are entitled to apply for the grant of representation (Senior Courts Act 1981, s 114(1)).
Although a grant is usually required to prove the personal representatives’ right to the assets there are a few exceptions:
- The Administration of Estates (Small Payments) Act 1965 provides that assets not exceeding £5,000 that are held by some bodies, such as the National Savings Department, can be distributed without a grant.
- A person with an interest in certain funds or investments of the deceased may transfer these to a nominated person by a written and signed direction without needing to produce a grant.
- Property held as joint tenants passes automatically to the survivor on death. Only the death certificate needs to be produced to update the legal title at the Land Registry.
- Life policies written in trust for the benefit of others that are payable directly to the named beneficiary may be realised without the need for a grant.
- Pension schemes that offer a lump sum on death “in service” may be payable to the nominated beneficiary without the need for the grant; merely the production of the death certificate is required.
- Personal chattels can be sold before a grant is obtained.
Inheritance tax account
The Inheritance Tax Act 1984, s 216 imposes a duty on personal representatives to deliver an account within 12 months of the end of the month of death; however interest will begin to accrue after six months. This is usually notified by production of an IHT400.
The Inheritance Tax Act 1984, s 256 permits HMRC to make regulations dispensing with the need to submit a full account in some circumstances. The most recent changes allowed excepted estates to submit a “short form” to HMRC for all applications for a grant made on or after 1 November 2004 for deaths on or after 6 April 2004. All applications in these circumstances must be submitted with an IHT205.
There are three types of excepted estates, each subject to their own conditions.
- Low-value estates. Estates where there can be no liability to inheritance tax because their gross value does not exceed the threshold.
- Exempt estates. Estates where there can be no liability to inheritance tax because their gross value does not exceed £1m and there is no tax to pay because of the spouse or civil partner exemption or the charitable exemption.
- Foreign domiciliaries. Estates where there can be no liability to inheritance tax because their gross value in the UK does not exceed £150,000.
If the conditions for an excepted estate are not satisfied, a form IHT 400 must be completed which is a full account to HMRC. Finance Act 1999 brought in stricter penalties for non-compliance, fraud and delay in delivering the account in the statutory period and incorrect information provided within the inheritance tax account.
Paying inheritance tax
To obtain the grant of probate any inheritance tax liability must be paid. Sometimes it may be necessary to sell items or close accounts to be able to make the payment and there is then a “chicken and egg” situation because a grant is required to undertake these tasks.
Since 1 April 2003, there has been a specific procedure to allow money in bank accounts and building societies to be paid directly to HMRC, as long as the account was in the deceased’s sole name and the institution is participating in the direct payment scheme. This can be achieved by submitting the completed IHT423 form to the relevant institution. Further, IHTA 1984, s 227 provides for an election to be made to pay the inheritance tax due on the value of particular assets by 10 equal annual instalments, rather than one lump sum. The first instalment is due on the date that the whole tax would otherwise be due if it were not payable by instalments. The qualifying assets where an instalment option exists are most commonly land or buildings, unquoted shares or securities (subject to exceptions) and the net value of a business. Interest is payable on the unpaid portion of the instalments and is added to each payment. The tax may be paid in full at any time once elected for the instalment option and is due when the asset is sold.
Should these steps not be sufficient to fund the tax payments, the personal representatives could consider taking out a short-term loan pending issue of the grant. Alternatively, family members or the beneficiaries themselves may provide such loans, instead of using a specialist company which might charge a high interest rate.
A further option is set out in HMRC’s Inheritance Tax Manual at IHTM05071, (“Obtaining a grant on credit”). This is available in very exceptional circumstances only when a grant is obtained before paying the inheritance tax as long as the personal representatives can show that it is impossible to raise the money before obtaining the grant. A request for such a grant on credit will be dealt with by Primary Compliance Technical Support, which ensures that any necessary steps (such as land charges) are taken to protect HMRC’s claim. Officers will ask for written undertakings to pay the tax within a specified period before allowing the grant and will monitor the case and make sure all undertakings are met within the specified periods.
The acceptance in lieu scheme (IHTA 1984, s 230 to s 231) enables personal representatives to transfer qualifying items (such as “important works of art and other heritage objects”) into the public ownership in settlement of an inheritance tax liability. The personal representative is given open market value, but there is an extensive application process and, ultimately, a panel will decide whether the item qualifies and the price that should be given.
If amendments to the estate as included in the inheritance tax accounts are discovered after the grant has been obtained, it may be necessary to submit a corrective account to HMRC using Form C4.
Once the administration of a deceased’s estate is complete and there is no reason to believe that there will be any further amendments to the tax payable on the estate, an application for a clearance certificate under IHTA 1984, s 239(1) may be made. This can be achieved by completing and submitting form IHT30 to HMRC. This certificate will discharge the taxpayer from further liability to tax on the property specified within the certificate.
Post-death variations
An original beneficiary is entitled to enter into a post-death variation which may be particularly useful in obtaining beneficial treatment for inheritance tax (under IHTA 1984, s 142(1)) and capital gains tax (under TCGA 1992, s 62(6)).
To be effective for tax purposes, a variation must be entered into within two years of the date of death. It must be in writing and signed by the beneficiary who is varying the gift. It must also include a statement relating to the respective tax provisions. It is prudent to ensure the personal representatives are also party to the deed for the variation to be effective for tax purposes. Note that a deed of variation cannot be used to gain income tax advantages because income received by the estate is payable by the estate rather than the beneficiary.
As an example, post-death variations can be beneficial to enable an estate to qualify for the full spousal exemption or to reduce the rate of inheritance tax payable by providing for 10% of the estate to go to charity. Similarly, a variation could ring fence an inheritance by placing it into trust if this had not been thought about before death. Another possibility might be to pass legacies to the next generation to avoid a potentially exempt transfer having to be made by the original beneficiary.
The government is consulting on the use of deeds of variation [2]. The consultation ends on 7 October, but readers with long memories will recall an attempt at reforming the rules in 1989.
Interest on legacies
Personal representatives may have to pay interest on two kinds of legacy. The first is a pecuniary legacy – a gift of money in a will. The will may direct when interest is payable and at what rate, in which case interest is payable on the pecuniary legacy from the due date that this should be paid.
The date of payment depends on whether the legacy is immediate. Such legacies are due to be paid within one year of the death of the testator because the executors are not bound to distribute the estate before the first anniversary (Administration of Estates Act 1925, s 44). The year starting on the date of death is known as the executor’s year. Executors must pay interest on an immediate legacy if they do not pay it within the executor’s year.
If a legacy is not immediate – for example, if it is payable when the beneficiary turns 21 – the executors must normally pay interest if they do not pay the legacy by then. If the condition has already been satisfied or if it is satisfied within the executor’s year, the executors do not need to pay interest before the end of that year. There are of course exceptions to this rule covering debts and legal charges.
The interest payable on pecuniary legacies in a will is the basic rate of interest paid by the Court Funds Office. That rate currently is 0.3%.
No interest is payable on a pecuniary legacy that is an annuity, except in exceptional circumstances (Re Earl Berkeley [1968] Ch 744).
The second case in which interest may have to be paid is if there is a statutory legacy for a surviving spouse or civil partner under the intestacy rules.
The statutory legacy is the sum to which the surviving spouse or civil partner of a deceased individual is entitled when the individual died intestate and there are other (close) surviving family members.
Interest is payable on the statutory legacy starting on the date of death (Administration of Estates Act 1925, s 46(1)). The current rate is 6%.
Residue and assent
The “residue” is the remainder of a deceased person’s estate after the payment of specific gifts, debts, funeral expenses and inheritance tax.
Assent is the act, by the personal representative of a deceased person’s estate, of transferring a legacy, or all or part of the residuary estate, to a beneficiary. An assent should take place only after the personal representative is satisfied that:
- the beneficiary is entitled to the legacy or share in the residuary estate;
- the estate has enough funds to meet it; and
- the beneficiary can give a valid receipt.
An assent establishes the beneficiary’s title to the asset or assets in question. An assent of a legal estate must be given in writing (Administration of Estates Act 1925, s 36(4)). A written assent is not essential for other assets, but is desirable because it confirms the date on which the beneficiary becomes the owner.
Conclusion
Death remains a taboo subject and clients and advisers may find it difficult to discuss the subject. Perhaps this accounts for the fact that most of us still die without making a will, despite knowing that we will all end up “leaving the building” at some point. As with most aspects of tax, and possibly even more so, the certainty of death means that advance planning can mitigate both the consequent tax liabilities as well as the associated administrative requirements.