Do sums wrong and you could pay DOUBLE inheritance tax as HMRC cracks down

Inheritance tax: Graham Southorn explains how trusts can help

HMRC issued a hefty £2.28million worth of IHT penalties in the 2022/23 financial year, an increase of more than a third on the year before. In two years, the taxman’s take from IHT penalties has increased by more than half, according to a freedom of information request by NFU Mutual. So make sure you don’t get caught.

IHT is complex and it is all too easy to find yourself penalised, said Sean McCann, chartered financial planner at NFU Mutual. “HMRC normally issues penalties to families who either undervalue the assets being passed down or fail to include them on their IHT return.” 

Families have to calculate how much IHT they owe and pay up within six months of the family member’s death. Otherwise they are charged interest on any money due.

A major problem is that it can take a lot longer than that to sell a property, especially today, and it’s hard to work out the true value until it is sold, leading to errors.

It may be wise to err on the side of caution. If you sell the property for less than you anticipated, which is more likely to happen today as house prices fall, you should be able to claim back any IHT overpayment.

The size of the penalty HMRC imposes on IHT miscalculations will depend on the nature of the error and whether someone deliberately set out to avoid paying tax due.

If the family failed to take “reasonable care” the penalty can be up to 30 percent of the unpaid tax, McCann said. “This regularly happens where families do not get professional valuations for property or other valuable assets, and understate their value as a result.”

If HMRC decides the family made a “deliberate” decision to provide incorrect information or fail to include assets on their IHT return, the tax penalty can rise to a punitive 70 percent.

It gets worse if HMRC decides you were hiding something. “Taking steps to hide errors is likely to be viewed as ‘deliberate and concealed’ and attracts a penalty of up to 100 percent,” McCann added.

In other words, you will pay twice the tax due.

Getting away with tax fraud is harder than ever thanks to HMRC Connect, a data mining computer system that cross-references people’s tax records with other databases to establish fraudulent or undisclosed activity.

This holds a staggering 55billion data items and it’s growing all the time. It covers everything from Land Registry property sales data to bank and credit card transactions, DVLA records and even your emails, social media posts and internet browsing history.

HMRC can reference this against the information on your IHT return, McCann said: “As latest figures show, HMRC does not hold back where it suspects underpaid tax.”

IHT rules are riddled with quirks and complexities so make sure you understand them in detail and seek advice if unsure.

Gifts to loved ones are typically free of IHT provided you live for another seven years, but there are exceptions to this rule.

For example, if you gift a property to your children but continue living there without paying a market rent, it could still incur an IHT charge. 

The same applies if you have regular overnight stays. It could even be liable for IHT if you nip round and borrow books from the property more than five times a year, in a particularly bizarre tax rule.

If you sell a property to a child at a reduced price, the difference between the sale price and market value is seen as a gift under IHT rules. So it may incur tax if you die within seven years.

In another bizarre rule, after gifting a car, you cannot accept more than three lifts a month in the vehicle otherwise it may become liable to IHT.

The payout from any life insurance policies may also be liable, unless they were put in trust. Many don’t realise this and face a huge shock.

Trusts also have pitfalls, though. Many wrongly assume assets held in trust are exempt from IHT but that only applies if you survive for seven years after gifting them (and in some cases 14 years).

HMRC netted a record £7.1billion of IHT last year and is on course to harvest £8billion in the current tax year.

The basic nil-rate threshold has now been frozen at £325,000 since 2009, catching more families as asset values rise in a process known as fiscal drag.

Stephen Lowe, group communications director at retirement specialist Just Group, said too many families fail to take advantage of IHT gifting allowances. “As HMRC rakes in more cash plan ahead to reduce your liability.”

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