US-UK Inheritance Planning: An Update
As we approach the end of the UK tax year we are often asked how parents can help their offspring and mitigate their own potential inheritance tax liability. In a previous post, we discussed the option of setting up a 529 Plan for children or grandchildren.
If one is not concerned with funding education, but rather wants to assist adult children or grandchildren in other ways, one should be careful to make use of the planning options available in each country and ensure they dovetail. To understand the options it is worth recapping on the estate tax rules for the United Kingdom and the United States:
The UK taxes an individual’s estate at 40% on all assets over the “nil rate band” which is curently £325,000. For married couples who are both domiciled in the UK for tax purposes the allowance is typically passed to the spouse on death creating an effective nil rate band of £650,000 at the time of the second death (provided this has not been used for gifts to children or others – see below).
The US has a $5.43 million Federal estate tax exemption (which is currently inflation-linked) and similarly you can combine the exemptions of both spouses, if proper planning is undertaken. The Federal estate tax is 40% just like in the UK. Also, if one holds “real property” in the US such as a holiday home, farm or other land, such assets could be subject to a state estate tax, depending on where the asset is located.
Don’t forget that as a US tax payer you will definitely owe US estate tax if your estate is greater than $5.43m, whereas UK inheritance tax may not be owed if you are not domiciled for tax in the UK. Tanager does not provide tax advice so you should refer to a suitably qualified professional to understand your UK tax position.
Both tax regimes allow individuals to reduce their taxable estate by gifting assets. Regular gifting over a period of time can not only reduce your estate taxes but can be a great way of helping family with, for example, school fees.
The UK allows for an annual gift exemption of £3,000. In addition, you can gift up to £250 to as many people as you want. In respect of mitigating inheritance tax you can make gifts out of income and potentially exempt transfers (aka PETs). The rules are not straightforward but when properly applied can be the means for making an effective transfer of assets out of your estate.
The US allows any individual to gift up to $14,000 to anyone every year ($28,000 per married couple) and a US tax payer can also make an annual gift up to $140,000 to a non-US tax payer spouse. This is particularly useful if the family plan not to return to the US and the non-US tax payer remains so.
The trick is to take advice from a team of professionals who are all up to date on your personal situation and who understand both the US and UK tax jurisdictions.
Here is an example:
John and Jessica Smith are in their 60s, retired in Oregon and are looking to help their only daughter, Susan, who lives in London with her Anglo-German husband, Erich and their two children. The Smiths can each give up to $14,000 to Susan and Erich every year and a similar amount to each grandchild. This would enable them to gift up to $112,000 every year and reduce their US taxable estate. They could make larger gifts but these would use up a portion of their $5.34 million US Federal exemption and a Gift Tax return would need to be filed to account for the gifts.
Erich’s parents, Mathias and Hildegard Wolf are domiciled in the UK for both income and inheritance tax purposes. They have significant assets, including a home in Notting Hill and a chalet in Kitzbuhel. Mathias retired 5 years ago as UK Managing Director for a large German car company and his net worth excluding real estate (which he jointly owns with Hildegard) is over £3 million. He has a defined benefit pension of £175,000 per annum and receives a further £70,000 in investment income. The Wolfs have no liabilities and live comfortably on Mathias’s after-tax pension.
Mathias could gift his after-tax surplus income to Erich and/or his grandchildren annually without using any of his UK “nil rate band” of £325,000. Alternatively, Mathias could liquidate investments and make PETs to members of his family. Were he to make gifts totalling £1 million on March 5th 2015, the gifts would not be subject to UK inheritance tax if Mathias survived to March 6th 2022. Should Mathias pass away before March 6th 2022 but after March 6th 2018 then the tax due would be calculated on a sliding scale.
Anyone considering gifting should consult their accountant and solicitor in tandem with their financial advisor to determine what gifting strategy is most suitable for them.