Inheritance tax - What the changes really mean
By Chris Gilchrist    17th October 2007

In the Pre-Budget Report, Chancellor Alistair Darling claimed to have doubled the amount a married couple can leave without paying inheritance tax.

Unsurprisingly, this isn't true, and millions of people still face a 40% death tax.

What Darling actually did in the PBR was to enable the unused 'nil rate band' to be transferred from one spouse to another. The 'nil rate band' is the amount you can leave free of tax, currently £300,000. To see how this works, let's start with a before-and-after comparison along Treasury lines.

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Before the change
Mr and Mrs Jones had assets of £600,000. Mr Jones died first and left everything to his wife. When she died, £300,000 was subject to tax and the kids paid £120,000 in tax.

After the change
Mr and Mrs Jones have £600,000. Mr Jones dies leaving everything to his wife. When she dies, his 'nil rate band' of £300,000 can be offset against her assets, so no tax is paid on her estate.

Now let's be more realistic and look at what most couples who've had sensible advice have actually done.

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Before and after: the reality
Mr and Mrs Jones have assets of £600,000. They divide the assets equally between them, including the house (which they switch from a 'joint tenancy' to a 'tenancy in common' basis of ownership).

They both make wills in which, if they are the first to die, they leave £300,000 to a trust. The trust is 'discretionary' which means it can hand out cash not just to the children but to the survivor. No tax is payable on the first death, and on the second death, the survivor also has assets of £300,000 so no tax is payable.

So, for many couples who have done sensible, simple inheritance tax planning, there is no benefit at all from the latest change. They weren't going to pay any tax anyway.

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Millions of losers
Shadow Chancellor George Osborne had proposed a £1 million threshold for inheritance tax, with every individual entitled to leave this amount. In contrast, Darling's measure only affects married couples and those in civil partnerships.

There are three million single parents who gain no benefit from the change. Though fewer of them will have assets of more than £300,000, it is still entirely arbitrary that single people pay 40% tax on every extra pound they leave while married couples can leave £600,000 tax-free.

This is of course a result of tax policy being made on the hoof, with the Labour government's tax change widely seen as a knee-jerk reaction to the popular enthusiasm for the Conservative proposal a few weeks earlier. In fact, it looks as if the measure was the centrepiece of an intended pre-election Budget, and it's a pity that Darling didn't scrap it when the election was called off.

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What you need to do
One positive feature of the change is that it applies retrospectively. If your spouse died without using their nil rate band to leave assets to other people, then you are entitled to set their nil rate band (or whatever bit of it they didn't use) against your own estate, regardless of how long ago they died. But you will need to prove that they didn't leave assets to other people in their will.

Actually it's a bit more complicated than that, which probably means a trip to the lawyer is required. Say Mr Jones died when the nil rate band was £250,000, and left £125,000 to the kids.

So he used half the nil rate band. That means that if Mrs Jones dies today, half of the current nil rate band will be added to her £300,000, so she gets an extra £150,000 (not an extra £125,000), making a total tax-free allowance against her estate of £450,000.

If you have a normal tax-planning will with discretionary trusts, your adviser or lawyer will probably suggest you review it. In many cases, it will still make sense to use trusts because they enable trustees to control the distribution of cash to younger members of the family. But in some cases it may make sense to change a will, especially if the property accounts for a large part of the assets and the total estate is under £600,000.

Some older people won't be up to speed with any of this stuff, but that's OK because their personal representatives or executors can sort this out after their death.

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The change is fact
The Capital Gains Tax proposals in the Pre-Budget Report were just that - proposals. They have come under heavy fire from the business lobby and may be changed before next Spring's Budget.

In contrast, the inheritance tax change is fact - effective from midnight on 9th October 2007, and the clauses that will be included in next year's Finance Bill already published on the HM Revenue & Customs website.

The price of marriage
I wonder if we will see an upsurge in marriages between older people. I can imagine that some of them will reason that if you have to get married to avoid paying £120,000 to the government, it's a price worth paying. I expect the lawyers are at work on the contracts now.

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