Small company owners can make considerable inheritance tax (IHT) savings by including a trust in their Will, and in April the introduction of the residence nil rate band (RNRB) could potentially increase those tax savings by up to a further £140,000. We look at the substantial reductions in tax that can be achieved.
Unquoted company shares benefit from Business Property Relief (BPR) which can reduce their taxable value to nil. At present if a small company owner leaves all their shares in their company to their spouse or civil partner in their Will the benefit of the BPR is lost. However, the inclusion of a trust in the shareholder’s Will can maximise the benefit of BPR and save significant sums of tax.
David owns a majority shareholding valued at £300,000 in Smith Technology, a trading company. He and his wife, Jane, jointly own a property worth £1.5 million and hold other assets and investments totalling £900,000. Their total estate is £2,700,000. The company is sold after David’s death. If David leaves all his assets to Jane in his Will there is an IHT bill to pay of £820,000 on Jane’s death.
Alternatively, if David leaves his shares to a discretionary trust in his Will (with Jane as a potential beneficiary) then the shares and their proceeds of sale are outside of Jane’s estate. BPR and spouse relief ensure that there is no IHT on David’s death. On Jane’s death her assets are reduced by £300,000 (the value of the shares in the trust) and there is a minimum tax saving of £120,000 under the current rules (ignoring for the moment the effect of the RNRB)
How the trust combined with the RNRB increases the tax savings
The RNRB comes into force gradually from this April and, when fully in force, will exempt up to £350,000 of a couple’s assets from IHT if they leave a house, or assets representing a home of which they have disposed, to their close family: children, grandchildren and their spouses and civil partners. The relief is tapered, however, once an estate exceeds £2 million. David’s shares even if they benefit from BPR count towards the £2 million total after which the RNRB begins to be lost.
If David leaves all his assets to Jane, as in the first part of the example above, his estate will not qualify for the RNRB as he has not left a home to his children or grandchildren. On Jane’s death she leaves the family home to the couple’s two children but does not qualify for the RNRB as her estate is too large causing the RNRB to taper away to nil.
By comparison, if David uses a trust in his Will, as in the second part of the example above, then Jane’s estate benefits from the £120,000 IHT saving referred to above and, in addition, as the value of the assets in her estate have been reduced to £2.4 million, her executors can claim £150,000 of the RNRB leading to an extra tax saving of £60,000. Using the trust therefore has a double tax saving benefit in these circumstances.
Further tax savings
Even greater tax savings might be achieved if the company was not sold following David’s death. Jane could then potentially buy the shares from the trust ensuring that the trust owns cash of £300,000 and Jane owns shares potentially subject to BPR. If she owns the shares for at least two years before her death, her executors could claim BPR again on her death leading to a further £120,000 tax saving.
In addition, it may be worth considering David using his available nil rate band to leave additional cash assets to another discretionary trust in his Will to further enhance Jane’s potential entitlement to the RNRB.
If you would like more details about how you can use your Will, trusts and the available reliefs to reduce the IHT payable on your estate, please contact us for an initial free, confidential discussion.