Keep it in the family

You can't thwart death but there are ways of avoiding the tax it carries, writes Matthew Hutton

YOU may think that inheritance tax (or IHT) planning is something that other people do. A lot of people manage to find ways to avoid paying IHT, but they do that by making use of certain allowances. This is why you need to take action if you (or your parents) have a home and assets worth pounds 223,000.

With rises in property prices, especially in the South-east, you may well find your parents' home is worth more than this. Unless they (or you) do something to cut the liability to IHT, then you will have to pay 40 per cent tax on everything they own above this figure.

IHT is also charged on any "chargeable" gifts made in the seven years before death so you cannot give all your assets away before you die in an attempt to help your heirs escape IHT.

The Budget next month is also likely to see the rules on inheritance tightened, so if you think your family may have a problem it is worth looking at it this month.

The Revenue does not get its hands on everything. Property left by one spouse to a surviving husband or wife is generally free from tax but having a professionally drafted will can prevent many problems later. If you live together without being married you do not qualify for this tax break.

One tip used by tax professionals is to arrange couples' wills so that on the first death they should leave the nil-rate band (the first pounds 223,000 of the estate) not to the surviving spouse but either direct to children or perhaps to discretionary trusts. This way the surviving spouse will benefit without the inheritance forming part of his or her chargeable estate.

At present you can vary a will within two years of someone's death to include more efficient IHT measures. However, this facility, which has been under threat for 10 years, could be scrapped in the Budget.

This year the Chancellor may well decide to abolish the "potentially exempt transfer" (PET). This neat rule allows you to make a gift worth any amount to an individual without it counting towards an IHT bill. To get round the possibility of people giving away all their assets, the giver has to survive for seven years afterwards.

If you can bring the subject up (which can be tricky), it would be a good idea to make such gifts, or ask your parents to do so, before the Budget rather than afterwards. Unfortunately there is another tax to take into account on giving during a lifetime - capital gains tax (or CGT). A gift is a disposal and counts for CGT in the same way as selling your assets.

This may not concern you as we each have an annual allowance before CGT is payable. This is currently pounds 6,800, so a couple can give away pounds 13,600.

Alternatively, where business or agricultural property is concerned, the gain can be "held over". This is an arrangement with the Inland Revenue and means you can avoid any immediate CGT charge. Instead, the individual or trustees receiving the gift take on the donor's base cost, adjusted by indexation allowance for inflation to April 1998.

The Revenue has also realised that some people might be sneaky enough to give away assets in name only. The so-called "reservation of benefit rules" make a gift ineffective for tax reductions if the donor continues to enjoy any benefit from what he has given away. That means your parents cannot go on living in their house, which is now in your name, without it still forming part of the estate.

The overriding rule is "don't give away more than you can afford".

Everyone can give away pounds 3,000 annually, and if this is not used up it can be held over for the next tax year (so this year you could give away pounds 6,000). You can also give away pounds 250 each to as many people as you like. However, the small gifts exemption (pounds 250) cannot be combined with the annual exemption, so you cannot give pounds 3,250 to one person.

If you are getting married your parents can give you pounds 5,000 (in addition to these allowances) and your grandparents can offer pounds 2,500. If you can do it tactfully, it is worth reminding them of all this before Budget day, on 9 March.

n Matthew Hutton is a chartered tax adviser and chairman of the capital taxes committee of the Chartered Institute of Taxation.