Inheritance tax is one of those things that most families know exists but few understand until it affects them directly. By that point, the options for addressing it are significantly narrower than they would have been ten years earlier.
This article is written for the people who will be affected by it — the children and grandchildren of business founders and asset holders — to explain what it actually means in practice.
The basic mechanics
Inheritance tax in the UK is charged at 40% on the value of an estate above the nil-rate band. The nil-rate band is currently £325,000 per person. There is also a residence nil-rate band of £175,000 per person, which applies when a main residence is passed to direct descendants. A married couple can combine their allowances, giving a total of £1 million before IHT applies.
For a family with assets above £1 million — which includes most families with a successful business — the IHT liability is real and significant. A family with £5 million of assets above the combined nil-rate bands faces a potential IHT liability of £2 million.
What Business Property Relief does and does not do
Business Property Relief reduces the IHT value of qualifying business assets to zero. It applies to shares in unquoted trading companies, interests in trading partnerships, and assets used wholly or mainly in a qualifying business. For a family with an active trading business, BPR can eliminate the IHT on the business itself.
But BPR does not apply to investment property. It does not apply to cash above what is needed for trading purposes. It does not apply to shares in investment companies. If your family's wealth includes a property portfolio, significant cash savings, or investment assets alongside the trading business, those assets are fully exposed to IHT.
The growth problem
The IHT calculation is based on the value of the estate at the point of death. But the estate is not static. A business that is worth £5 million today may be worth £10 million in ten years. A property portfolio worth £2 million today may be worth £3 million in ten years. Every pound of growth that accumulates inside the estate is exposed to 40% IHT.
The constitutional architecture ring-fences future growth from the estate from the moment it is installed. Growth above the existing asset value accumulates inside the structure rather than inside the estate. The IHT liability is fixed at the point of installation and does not grow with the wealth.
The seven-year rule
Gifts made to individuals more than seven years before death are outside the estate entirely — no IHT applies. Gifts made within seven years are potentially exempt transfers, with a sliding scale of IHT relief depending on how many years before death the gift was made.
This means that the earlier your parents begin gifting assets to you — through a Family Investment Company, a trust, or direct gifts — the earlier the seven-year clock starts running. A gift made when your parents are 55 starts a seven-year clock that expires when they are 62. A gift made when they are 70 starts a clock that expires at 77.
The architecture that addresses IHT is not complicated. But it requires time to work. The earlier it is installed, the more of the estate it protects.