Inheritance tax should be reformed so that Britons can hand more of their wealth to their children without paying the levy, an official review suggests.
Currently gifts of money, property or possessions made in the seven years before someone’s death may be liable to inheritance tax. Under the new proposal, the threshold would be reduced to five years.
The review also said the confusing rules around leaving cash and property to loved ones should be overhauled.
Inheritance tax remains ‘unpopular and raises strong emotions’ often because it is ‘poorly understood, counter-intuitive, and requires substantial record-keeping’, experts found.
Currently in the UK gifts of money, property or possessions made in the seven years before someone’s death may be liable to inheritance tax. Under the new proposal, the threshold would be reduced to five years. File image used
The report by the Office of Tax Simplification (OTS), an independent adviser to the Treasury, comes as high property prices, longer life expectancies and fears over social care costs mean the tax has become a contentious political issue.
The OTS launched its review after complaints that vague rules on inheritance tax were being exploited by those with access to expensive financial planners.
Reduce the seven-year rule for gifts to be tax-free so individuals only have to survive for five years after making a gift.
Abolish ‘taper relief’, which sees the amount of tax owed gradually reduce once the donor has survived for three years after handing over the gift.
Replace the annual gift exemption and ‘marriage exemption’ with an overall personal gifts allowance.
Reconsider the level of gift limits, which have remained frozen for decades.
The report was published yesterday, days after Shadow Chancellor John McDonnell said he was interested in replacing inheritance tax with a ‘lifetime gifts tax’ on cash or homes given to children.
The Tories accused Labour of plotting a tax raid on the middle classes.
The OTS report found that one of the biggest areas of confusion on inheritance tax was around gifts made during a person’s lifetime. Inheritance tax is charged at 40 per cent on estates worth more than the tax-free level of £325,000, or £650,000 for couples.
The seven-year rule applies to gifts above these levels, but figures showed that the amount of tax raised in the final two years did not justify the difficulties that families face over record-keeping, the report said.
Individuals are also allowed to make a number of gifts each year free of tax, regardless of how soon afterwards they die.
But the OTS report found the rules around gifts were too complex, and recommended a range of measures to simplify them.
For example, it suggested replacing the annual £3,000 gift exemption and ‘marriage exemptions’ – wedding or civil ceremony gifts worth up to £5,000 (£10,000 per couple) – with an overall personal gifts allowance.
The OTS did not specify what this limit should be, but urged the Government to recognise that these allowances have been frozen for decades.
The report is the second part of an inheritance tax review ordered by Chancellor Philip Hammond in January 2018. The OTS’s first report last November said the tax was ‘uniquely unpopular’.
In its second report, the OTS recommended a series of measures to make the tax simpler. On top of the normal £325,000 allowance (£650,000 for couples), there is also an extra tax-free allowance for homes passed to direct descendants.
This currently stands at £150,000 (£300,000) and will increase to £175,000 (£350,000) by Aprilnext year.
The rise means parents will be able to pass on an estate, including their main home, worth a total of £1 million to their children tax-free.
The new relief has been widely criticised as unnecessarily complex, but the OTS report concluded that it was too soon to recommend any reforms because it has only just been introduced.
A Treasury spokesman said: ‘We will consider the OTS recommendations carefully and will respond in due course.’
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, 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 – known as the residence nil rate band – 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.
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.