When drafting gifts under a Will thought should always be given to inheritance tax: who will pay it and what rate it will be charged at. Most people know that if you leave a share of your estate to charity then it can reduce the rate at which the rest of your estate plays inheritance tax (and if you didn't know then please see this blog). But did you know that there are circumstances in which your estate could actually pay IHT at a higher rate??
This phenomenon is called grossing up.
Where an estate is left to a mixture of exempt beneficiaries (such as a spouse/charity) and non-exempt beneficiaries (children or friends) then inheritance tax should only be paid by the non-exempt beneficiaries. I will caveat that by saying that this only becomes an issue where an estate is taxable. However, where it is, an active decision needs to be made as to how the inheritance tax is to be settled. For example, if the testator wants to leave £500,000 to his children with the residue to his spouse. This either needs to be drafted so that the gift to the children is subject to tax (meaning they receive £430,000 assuming a full nil rate allowance is available) or the tax is to be paid from the residue passing to the spouse, meaning the children actually receive £500,000. If the tax is to be paid from residue then a grossing up calculation needs to be undertaken. This requires the executor to calculate what the gifts to the children should be (before tax) for them to receive the gift of £500,000 net of tax. In the above example, the gift would be grossed up to £616,666.67 to enable the children to receive £500,000 free of tax. This actually results in a larger charge to IHT: £116,666.67 instead of £70,000 when the gifts were given subject to tax. Who would have thought!!
Because of this phenomenon, it is important to consider the tax implications on an estate of the various gifts set out in a Will. Grossing up is not only unfortunate when it hasn't been considered but can also create difficulties for executors who have to ensure they correctly report the inheritance tax due on an estate (or they could find themselves personally liable to HMRC).
Wills should always be written with probate in mind and considering any complications or complexities that it may create for the executor.
If you would like advice and assistance with preparing your Will (whether or not grossing up may be an issue) then please get in touch with Ashley Minott on email@example.com or on 01494 893518.