Chancellor Philip Hammond has ordered a sweeping review of inheritance tax and whether it ’causes any distortions to taxpayer decisions’.

Officials are set to probe everything from submitting returns and paying tax, to making IHT-free gifts and estate planning – but there is no indication of whether the 40 per cent ‘death tax’ on estates over a certain level could be cut, or increased.

The Chancellor’s move comes in the midst of complicated changes by predecessor George Osborne, under which you can pass on more than before without a tax penalty – but only if you own your home and give it to direct descendants.

There are also complicated rules on passing on assets tax-free if you live for seven years, giving gifts out of income, and out-of-date exemptions such as only allowing £5,000 to be given tax-free to pay for a wedding.

Inheritance planning: Property boom of recent decades means more people now have to shell out 'death tax'

Inheritance planning: Property boom of recent decades means more people now have to shell out ‘death tax’

Hammond calls the current inheritance tax regime ‘particularly complex’ in a letter to the Office of Tax Simplification – an independent arm of the Treasury, which will carry out the review.

The Chancellor asked for proposals for simplification, ‘to ensure that the system is fit for purpose and makes the experience of those who interact with it as smooth as possible’.

In theory a married couple or civil partners will be able to pass on an estate worth £1million including their home from 2020. 

Despite the fact that most estates don’t pay it, inheritance tax is hugely unpopular and families will be worried that a simplification or overhaul could be used to grab more tax. Read more here about how inheritance tax works.  

A more detailed version of the brief handed to the OTS will be hammered out in coming weeks, and no deadline for officials to report back has been set yet.

Sarah Coles, personal finance analyst, Hargreaves Lansdown, said: ‘Hammond suggests the Office of Tax Simplification looks at whether the current inheritance tax framework distorts decision-making.

‘Well we can save them the time, because of course it does. The tax framework distorts people’s behaviour and financial decisions, and inheritance tax is no exception.

Should inheritance tax be a flat 20% 

Removing or revising the complex set of exemptions is one way to make IHT simpler. 

A proposal put forward by some is to switch the tax-free allowance around and give it not to estates but to individuals, allowing them to  inherit a certain amount in their lifetime and then taxing them above that level.

Another way would be to have one main allowance with no other exemptions and cut the tax level to a lower 20%.

> Simon Lambert: Solve the IHT problem by cutting it to 20%

‘Anyone who has ever wrestled with estate planning and inheritance tax can appreciate that the whole system can be a nightmare of complexity.

‘The pension freedoms and the additional residence nil rate band may have reduced IHT for many, but they have made things much more complicated rather than less, so it’s about time someone took a big red pen to the myriad of rules and regulations.’ 

Rachael Griffin, tax expert at Old Mutual Wealth, said: ‘The Office of Tax Simplification pointed to inheritance tax as an area ripe for reform in its plans for the year ahead and with the weight of the Chancellor behind it, the OTS has a golden opportunity to simplify this complex area of taxation.

‘The inheritance tax system is not straightforward and has a number of legacy clauses and exemptions that the government could seek to reform.

‘One of the best examples of over-complication in death taxes is the residence nil rate band (RNRB), which is incredibly complicated and causes a lot of confusion.

‘Our research revealed that 70 percent of people have no idea how the RNRB works. An easier method to achieve the same goal would be to simply raise the standard nil rate band amount to £1million.’ 

Sean McCann, chartered financial planner at NFU Mutual said: ‘This review is long overdue. Inheritance tax is fiendishly complex with many tax traps for families who don’t take financial advice. 

‘A simpler system that people can easily understand is desperately needed. Even the most recent change, the Residence Nil Rate Band, introduced last April to help people pass on more of the value of their family home to their children and grandchildren, is riddled with ifs and buts.

‘Since it was brought in, we’ve seen a surge in the amount of IHT being paid with more than £5.3billion taken from people’s estates in 2017.

‘It’s clear from the most recent HMRC receipts that the taxman is already turning up the heat with inheritance tax by looking more closely at people’s estates and challenging claims for reliefs.

‘If the taxman is taking more in inheritance tax, it’s usually because house prices have gone up, raising the value of many people’s estates. But as property prices haven’t been shooting up at the same rate, it’s difficult to see what could have caused such a sharp increase other than a more aggressive approach to inheritance tax.’

What could change? Find out what Hammond might do below 

How does inheritance tax work? 

Inheritance tax was originally designed as a levy on the very wealthy, but triple digit property inflation since the 1980s has dragged more ordinary families living in expensive areas into its net.

Just 5 per cent of people leave estates sufficiently large to make their beneficiaries liable for inheritance tax. 

However, the property boom of recent decades means that figure is expected to rise to 10 per cent by 2019, with those inheriting in house price hotspots bearing the biggest financial burden.

Essentially, you need to be worth £325,000 if you are single, or £650,000 jointly if you are married or in a civil partnership, for your loved ones to have to stump up death duties. 

But a new own home allowance lets you pass on more than that.

If you have a partner, own a property, and intend to leave money to your direct descendants, that threshold has started to rise in stages and will reach a joint £1million by 2020. 

Currently, passing on your home gives you an extra £100,000 to create a total individual allowance of £425,000, or joint allowance of £850,000.

If you are worth more than this, your heirs will have to hand over 40 per cent of your assets above those levels to the Government.

> Read more about reducing your inheritance tax bill here 

What changes could the Chancellor make to inheritance tax?

Hargreaves Lansdown says any of these issues could be up for review:

Seven-year rule on gifts: ‘The current rules state that after seven years, any gift is considered out of your estate for inheritance tax purposes,’ says the financial services firm.

‘This rule is widely misunderstood, and in certain circumstances IHT can still apply to gifts made up to 14 years before death. It can also encourage people to make large gifts before it makes financial sense for them. There has been some speculation that this period could be reduced to two years.’

£3k gift rule: ‘Each year, anyone can give away £3,000 of their assets in gifts free of inheritance tax. This figure has not changed for over 30 years, and if it had increased with inflation it would be around £9,500.’

Change coming? Philip Hammond calls the current inheritance tax regime 'particularly complex'

Change coming? Philip Hammond calls the current inheritance tax regime 'particularly complex'

Change coming? Philip Hammond calls the current inheritance tax regime ‘particularly complex’

Nil rate band and home rate band: ‘The residence nil rate band is a relatively new addition, and is in the process of being phased in. It would be unusually early in the process to make a change, but would make life easier if it was merged with the nil rate band to form one simpler allowance.’

Passing on pension pots: ‘ Since pension freedoms, it’s now far more tax-efficient to pass your pension onto the next generation than it is to pass an Isa, because pensions are free of IHT (in the vast majority of cases) and Isas are not.

‘This has been very popular with pension savers, but has had a big impact on the way people view savings and investment in retirement.

‘Death taxes have always had the potential to distort planning decisions, but since the pension freedoms, the IHT efficient solution has been to take a U-turn on how you spend your retirement savings.’

Capital gains tax rules: ‘Capital gains tax washes out on death, so one way to avoid paying capital gains tax is never to sell anything. Of course on death there could be IHT to pay but CGT is a considerable barrier to investment decisions.’

Rules on trusts: ‘Taxation in 2006 brought together a whole range of trust regimes into two, with monumentally complicated tax treatment.

‘In some cases there are tax charges on entry, periodic tax charges and then exit charges. The regime was designed to make tax avoidance more difficult, but in the process added to what was already a complex regime. This is an area ripe for simplification.’

NFU Mutual suggests the review could lead to radical changes:

Tax allowance switches to inheritance recipient: ‘The review could see the introduction of radical changes, charging inheritance tax on the person who receives the inheritance rather than the estate of the deceased,’ says the insurer.

‘Each recipient would have a tax free allowance based on their relationship to the person making the gift. 

‘For example a parent could make gifts of up to £250,000 per child during their lifetime or on death, a grandchild could receive £50,000, a niece or nephew £25,000, or anyone else £15,000. The recipient would then pay tax on anything above these limits.’



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