BACK TO BASICS
Tax on death
A sombre topic for this month’s article, but one that can’t be ignored. The chances are most readers of these words will have dealt with the estate of someone who has died or will have to at some point in their lives.
Inheritance tax
This is the most obvious tax that one thinks of in the context of a person’s death, of course. Inheritance tax (IHT) becomes chargeable on the value of the estate, subject to certain reliefs. First of all, estates worth less than £325,000 (currently) are not charged to IHT. Second, an estate that is left to a surviving spouse or civil partner is exempt and does not use up any of the £325,000 zero-rate band. Third, certain reliefs are available, like business property relief for trading businesses and, broadly speaking, shares in private trading companies, and agricultural property relief for farms and farm houses etc.
Owing to a strange quirk in the procedure, IHT has to be paid before probate is granted. Probate means getting a registrar to confirm that the will you take along to him is the valid last will and testament of the deceased, and gives effect to the will’s appointment of you as executor. Once you’ve been appointed as executor, you are able to get your hands on the assets, which you need to do for a number of reasons, not just so that you can distribute them to the people named as beneficiaries in the will but also so that you can pay IHT.
Have you spotted the flaw here? You have to pay the IHT before you can become executor, but you can’t get the money to pay the IHT until you’ve been appointed executor.
There are various ways round this, including taking out special loans for the purpose, but it does seem a daft rule.
Capital gains tax
If there is any good news in this context, that good news is in the context of capital gains tax (CGT). Where a person owning an asset dies, the asset is treated as re-based up to its market value on the date of death, for CGT purposes. This means that if the beneficiaries of the will then go on to sell the asset, they only pay tax on any gain in value over and above probate value (i.e. value on death). This can be particularly valuable, of course, where the asset owned by the deceased had a very large and substantial gain on it. The gain is effectively washed out, tax-free.
There is also a special capital loss relief on death, under which you can carry back losses made in the last tax year of the person’s life to previous years, something you can’t do in any other circumstances.
Income tax
The only other tax you’re likely to have to think about is income tax. The deceased is likely to need a tax return done for the period from the 6th April prior to death up to the date of death, that is for the last stump tax year. In most cases this is likely to lead to a repayment of income tax, because had the deceased been receiving income under PAYE (like salary or pension) the PAYE system will not have given him all the allowances he was due for that last year. There may also be tax to come back on investment income, like interest received.
Death is not an occasion (in most instances, anyway) for the taxman to charge income tax on life insurance policies.
The greatest complication with income tax on death, though, is likely to be the income tax affairs of the estate itself. The estate pays tax as, effectively, a trust, but the income that is paid out to beneficiaries during the period of administration of the estate becomes the beneficiaries’ income in the year in which they receive it, with a credit for the tax that the executors have paid. All in all, it’s taxed very much like a trust. Unless you know what you are doing, it probably makes sense, if the numbers are large enough, to use an accountant for this bit.