How do you apportion the tax liability between two estates?

Trusts Discussion
1

I am dealing with the administration of an estate whereby he had a life interest in half of a property by his late wife who predeceased him in 1980s. I understand that the trust is aggregated with his free estate in order to calculate IHT. I understand that NRB/TNRB/RNRB/TRNRB are then applied and the tax liability is apportioned between the trust and the estate. Please can someone tell me that is correct and let me know how the liability is apportioned? Is it simply based upon the value in the trust (i.e., the half share of property) divided by the value of the trust and free estate x by the liability?

Presumably then the trustees are liable for the tax on behalf of the trust?

Thanks for your help

Charlotte Otton
Slater Heelis

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Basically you are correct. The so-called “free estate” of the deceased (eg 600K) is added to any “estate interest in possession” (eg 300k) to give estate of 900k (less NRN/RNRB and transferable amounts) then chargeable to IHT at 40%.

Assume, say, NRB 325K plus RNRB 175K ie 500k.

900k less 500k taxed at 40% gives 160k.

Estate rate is 160k/900k ie 17.7778%.

IHT payable by trustees is 300k x 17.7778% gives 53,334.

Or alternatively [300k/900k] x 160k gives 53,333,

Malcolm Finney

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Malcolm, thank you this is v. helpful. Would this “formula” however still apply if say the ‘free estate’ of the deceased were only £500,000 (and therefore within the NRB/RNB)? i.e. would IHT still be payable from the free estate or borne solely by the trust?

I am looking at IHT against free estate - #2 by paul where the residue is exempt due to spousal exemption, but cannot find guidance / authority on whether a parallel is drawn where the ‘free estate’ is within the NRB (so no chargeable estate and only chargeable by virtue of the trust being aggregated).

Many thanks in advance

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If Free Estate 500k and interest in possession say 300k then:
IHT at 40% of [800k - 325k - 175k] = 120k
Estate rate 120k/800k = 15%

IHT on Free Estate is thus 15% x 500k = 75k
IHT on Trustees is thus 15"% x 300k = 45k

So although the Free Estate of 500k is in a sense covered by the NRB plus RNRB, total 500k, the IIP causes some of the total IHT to be allocated to the FE (fairly or otherwise).

Picking up Paul’s comment and using the above figures if the whole of the FE of 500k passes to a surviving spouse this amount is exempt from IHT.

So the calculation. becomes:
500k less 500k ie Nil.

The 300k IIP is reduced by NRB plus RNRB ie 500K giving Nil.

Hence no IHT arises either on the FE or the trustees on the IIP.

Malcolm Finney

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Thank you v much Malcolm and apologies in advance for the further example but this seems a v. harsh formula where e.g.

free estate £250,000 (only one NRB no RNRB available) and interest in possession trust £200,000, thus giving the free estate (which would otherwise be exempt) an IHT liability of £27,775, but the trust only £22,220.

In theory I always understood this to be the case but seeing it play out in reality it has made me question my understanding (but as you say, fairness maybe simply does not come into it!)

6

I understand your comments, Skippyp, but I think it depends upon the situation.Having said this, I haven’t really thought about the underlying rationale (!!) but others may have.

EXample 1
If you own your house worth 500k then on death no IHT arises due to NRB 325k and RNRB 175k (assumes house left to children).

If you chose to settle it giving yourself a life interest there would be no IHT charge on settlement creation but on your death you would have a liability based on 500k as you are deemed to effectively own the house. As above your estate would be entitled to a NRB and RNRB.

The IHT consequences are identical in each case which arguably seems “fair”.

Example 2
Single woman (W) owns her own house worth 500k. On death house left to children so no IHT charge on death.

Prior to dying W marries H with her children living in her house whilst she moves in to H’s house worth 1,050k.

H dies leaving W with a life interest in H’s property with his children benefitting thereafter.

W then dies. On W’s death her estate comprises her own home 525k PLUS 1,050k due to her life interest in H’s property.

IHT on W’s estate = 500k + 1050k - [325k + 175k] = 420k
Estate rate = 420k/1550k = 27%.

IHT on W’s Free estate = 27% x 500k = 135k
IHT on life interest = 27% x 1050k = 284k

This on her own W’s IHT is Nil but marrying H and being given a life interest in H’s property has created for W’s estate an IHT charge of 135k where previously there was none.

W’s children therefore are effectively penalised and inherit less of W’s estate.

Presumably, neither W nor her children are aware of the adverse IHT consequences of W being granted a life interest in H’s home post H’s death. Arguably W and her children are paying a heavy price for W’s occupation of H’s home post his death. Maybe if H’s children and W all “get on” H should not give W a life interest in his property but, informally, W continues to live there??

Malcolm Finney

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When you aggregate free estates and settled estates the results are often “not fair” in teh eyes of the beneficiaries. Especially where in Malcolm’s second example the Wife gives up her life interest and then dies so that all her NRB is used by the PET and none is available for the estate

Just picking up on Malcom’s first example i don’t see that the RNRB would then be available after settling the property as the original gift would not be to a lineal descendant but to trustees. Would be OK for RNRB of original gift was to the children. Also as RNRB cannot be set against lifetime gifts there would be a charge on setting the trust up

8

From my above post ignore the gobbledygook of my second sentience beginning/ending “If you chose … entitled to a NRB and RNRB”.

I think what I was trying to do was to compare an IPDI with absolute ownership. The possession of an IPDI wrt the 500k house (but no Free estate) creates an IHT charge on death albeit subject to an NRB and RNRB giving an IHT charge of Nil attributable to the settled property.

Malcolm Finney

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I think I have mentioned this some years ago, but when advising clients who want to give someone a life interest, possibly, possibly a spouse on a second marriage who has a relatively small estate, which, because of aggregation would be liable to tax, whereas on its own, it would not, I have suggested that to compensate the beneficiaries of the life tenant for the tax, they ought to consider, giving their beneficiaries legacies possibly equal to the amount of tax borne by that spouse’s estate. What do others think?

Patrick, Moroney

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Patrick, this presumably is an option but would I suspect require that the children of the person granting the life interest are in agreement to their parent giving such legacies which, of course, would eat into the childrens’ inheritance. It may well be that the children would be reluctant to agree to their father leaving legacies where they do not get along with their father’s new wife. But, I agree, the suggestion doesn’t seem unfair when looked at objectively.
Malcolm Finney