Many spouses and civil partners are under the impression that anything they gift to each other, whether during their lifetime or on death, is fully exempt from inheritance tax (IHT).
However, there is an anomaly arising from domicile which can have serious IHT consequences for some couples. Spouses and civil partners are referred to as ‘married couples’ and ‘spouses’ below for brevity.
The full IHT exemption is not available where the assets pass from a spouse that is UK domiciled to a spouse that is not UK domiciled. It is only in this particular mixed domicile scenario where assets pass from a UK domiciled spouse that the problem arises.
If assets pass from a non-UK domiciled spouse to a UK domiciled spouse, or both spouses share the same domicile (i.e. they are both UK domiciled or non-UK domiciled), then assets should pass between them during their lifetime and on death without an IHT charge.
This means that spouses who have different domiciles are often completely unaware that their tax position can be more complicated than perhaps they think.
What does this mean in practice?
Until the tax year 2013/14, where a UK domiciled spouse left or passed assets to a non-UK domiciled spouse, there was a fixed exemption of £55,000 available in addition to the IHT nil rate band of £325,000 (assuming this had not been used for other gifts), the balance of the estate generally being subject to IHT at 40 per cent.
In tax year 2013/14, the £55,000 exemption increased to match the prevailing nil rate band (currently £325,000). As a result, the current combined maximum relief for mixed domiciled couples is £650,000. This allowance covers gifts between the spouses during their lifetime and on death.
Unsurprisingly, spouses often transfer assets between themselves for reasons completely unconnected with tax, unaware that such transfers might have a tax implication.
In the absence of a full spouse exemption, unless a mixed domiciled couple’s joint estates are relatively modest in size, the couple is likely to have an unexpected IHT bill.
Without advance planning therefore, such a couple may suffer IHT on both of their deaths.
Awareness of this anomaly is of primary importance.
If, as a married couple, you think this anomaly might apply to you, it is possible to take steps to mitigate its impact.
This can be achieved through forward planning and/or via an election by the non-UK domiciled spouse. However, forward planning is preferable because the election goes much wider than merely giving the non-UK domiciled spouse the benefit of the spouse exemption; it treats the non-UK domiciled spouse as UK domiciled for all IHT purposes, with the consequence that the non-UK domiciled spouse’s worldwide estate comes fully within the IHT charge.
As a result, the election should be used with extreme caution.
How can RSM help?
RSM can advise you on your mixed domicile status and how this impacts on your tax position during your lifetime, on death and on your estate planning. We can also advise on a range of related matters including implementing legal structures associated with estate planning, reviewing your existing wills and preparing new wills, etc.
If you would like more information please get in touch with Sophie St John, or via your normal RSM contact.
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