Page last updated at 16:07 GMT, Sunday, 4 May 2008 17:07 UK

Inheritance tax for cohabitees

MONEY TALK
By Penny Bates
Tax partner, Menzies chartered accountants

Penny Bates

The two Burden sisters from Wiltshire have lost their long-running legal campaign to avoid inheritance tax on their jointly owned home.

They had asked the European Court to be treated in a similar way to married couples and civil partners (CPs) for inheritance tax purposes.

Unfortunately for them, the court said no.

But what, if anything, can other people do if they are in a similar situation and want to avoid a potentially sizeable inheritance tax bill?

The basics

It is worth remembering the basic rules of inheritance tax, which are complicated.

Spouses and CPs are able to transfer property between themselves at death (and also in their lifetimes) without any charge to inheritance tax.

For them, it is only on the second death that the tax is payable on the whole estate held by the survivor.

It used to be the case that at that point, the first 312,000 - the current inheritance tax allowance - would be exempt from tax, while the balance was taxed at 40%.

However, the chancellor changed the rules with effect from 9 October 2007.

This means that if the first to die has not used the full allowance, then the unused proportion can be transferred to the survivor.

So up to two full inheritance tax allowances are available to set against the value of the estate when the second spouse or CP dies.

The Burden sisters

None of these rules apply to cohabiting couples in either same-sex or opposite-sex relationships.

The sisters, in fact, own three properties... A sale of one of those would probably result in cash to pay the inheritance tax

The Burden sisters cannot benefit from the spouse or CP exemption or the newly-introduced transferability of the nil rate band.

The judgement confirmed that the favourable inheritance tax rules would not apply because "despite its long duration, [the relationship was] fundamentally different to that of a married couple or civil partnership's couple".

Nevertheless, each sister still has an allowance available to her.

But the sisters argued that on the first death, the survivor would still have to sell their jointly-owned homes, worth approximately 875,000, as one half-share would be assessed for the tax.

It was suggested that the tax liability would be in the region of 50,200.

It is worth noting that according to court papers, the sisters, in fact, own three properties, one valued at 550,000 with its adjoining land, and two other properties worth 325,000 in total.

A sale of one of those would probably result in cash to pay the inheritance tax and possibly leave some left over to invest to produce an income or simply for the survivor to live off.

The sisters' bill

How much tax is involved for the Burdens as opposed to spouses or CPs?

Joyce Burden, 90, (left) and her sister Sybil, 82
The Burden sisters have finally lost their legal fight

In the sisters' case, there are two points when tax will arise.

On the first death, it would be 50,200 as mentioned above.

And when the second sister dies, it could be a further 225,200, assuming all property values and inheritance tax rates remain the same.

The higher tax charge arises on the second death because the surviving sister will hold the whole value of the house at the time of her death.

However, there is specific tax relief available where deaths follow each other in close succession (within five years), which acts to reduce the overall charge.

Technically, there could be an argument that the value of the sister's half-share of the property could be discounted and hence lower the amount of IHT at the time of the first death.

Married couples

By comparison, in the case of a married couple, on the first death, the house passes wholly to the survivor, so there is no tax to pay as it is exempt.

On the second death, the whole value is subject to inheritance tax, but each spouse's nil rate band can be used, if unused previously.

Therefore, the calculation is as follows:

  • Value of house - 875,000
  • Two allowances - 624,000
  • Amount chargeable to tax at 40% - 251,000
  • Tax due at 40% - 100,400

Spreading the Tax

The problem of paying such a large amount would have been partly alleviated, because tax law recognises that where land and property is concerned, it is often difficult for the executors to be able to pay the tax bill in one sum.

The house
The sisters' Marlborough house is valued at 550,000

So there are rules to allow payment to be spread over a maximum of 10 years.

On the figures reported, therefore, the surviving sister would need to pay no more than 5,020 a year to satisfy the inheritance tax liability.

Interest is, of course, added.

This is not a unique situation, as many couples of the same or opposite sexes cohabit long-term.

Insurance

Some advance thought should enable others in a similar situation to fund the liability via other methods.

One step the sisters could have taken would have been to take out a life insurance policy.

The sisters could have insured their lives for a sufficiently large sum to make sure that the necessary money was available to pay the expected tax bill when they died.

This is something they would have needed to think about some years ago, as they are now of such ages that it may prove impossible to obtain insurance cover.

Mortgage and savings

An alternative might have been for them to raise a mortgage from their property and to invest the funds into a discounted gift scheme, which is a tax-efficient vehicle.

Tax law is written in many areas to benefit those who have made contractual commitment to each other

The scheme would return 5% a year to help pay the mortgage interest on the loan. The value of the invested money would be outside of their estates for inheritance tax purposes.

Part of this value would fall outside immediately, with the remainder leaving their estates totally after seven years.

Again, this is planning which they should have considered a few years ago, as their ages probably mean that they are now uninsurable.

To be able to enter into a discounted gift scheme arrangement, the investors need to be insurable.

In view of the relatively small amount needed each year to pay the tax in instalments (5,020), a simpler plan would have been to arrange to pay this from any savings.

Fundamentally, though, the court judgement reinforces the fact that tax law is written in many areas to benefit those who have made contractual commitment to each other, either through marriage or entering into a civil partnership.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.



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