Stepping Stones: Estate and inheritance tax planning

Case study

Jason moved to the UK from New York in December 2006 and is a US citizen. In July 2005, he married Maria but they are since divorced. Jason is 51 and in good health and he has three children. He owns a UK property worth £1m, a US bank account worth $3m and cash in UK bank accounts worth £1.5m. Jason wishes to pass his wealth on to his children. Jason heard that the UK Inheritance tax (IHT) rules have changed recently for non-UK domiciliaries and he was concerned about his worldwide exposure to inheritance and estate tax, so approached Buzzacott for specialist advice.

What can Jason do?

As Jason has US and UK estate and inheritance tax exposure, with no planning in place he will most likely be exposed to a 40% inheritance tax bill on his worldwide estate. In the UK, each individual qualifies for the nil rate band (currently £325,000), meaning the first £325,000 of their estate is excluded from UK IHT. US estate or gift tax is only applicable where the total value of a deceased US citizen’s estate exceeds the lifetime exclusion amount. The US lifetime exclusion is currently $11.58m.

As Jason’s estate ($6.25m) is under the US threshold, his primary concern will be UK IHT, but he should consider how to preserve his exemption where possible. 

Lifetime gifting

One of Jason’s UK bank accounts has a cash balance of £500k. He would like to pass the cash to his children in a US and UK tax efficient manner and wants to give them the gift directly.

For UK tax purposes, a gift can be fully excludable from IHT if the donor survives seven years from the date of the gift. If the donor dies within seven years, the gift remains taxable in their estate. Jason is in good health and expects to live seven years.  

For US estate tax purposes, any lifetime gifts will be deducted from the lifetime allowance (currently per person) but it is possible to gift up to the annual allowance (currently $15,000) of your estate, per recipient, each year, without reducing your estate allowance. 

Jason could therefore gift up to $15,000 to each of his three children per year, with the gifts remaining outside the scope of US estate tax. Provided he lives seven years from the date of the gift, they will also not be subject to UK IHT. In addition, there is an annual UK gift allowance of £3,000 to each child and potentially if the gifts are considered regular and out of Jason’s income, they could be entirely exempt gifts without the need to survive seven years.

If Jason gifts $15,000 (approx. £11,500) to each of his three children annually, over a 10 year period, he could exclude £345,000 from his taxable estate. If Jason remains with the US gift annual allowance of $15,000, he could save £138,000 in taxes.

Deemed UK domicile

UK domiciled individuals are subject to UK IHT on their worldwide assets. Non-UK domiciled individuals are only subject to UK IHT on their UK status assets.

Under general UK law, it is possible to keep your domicile of origin in the US, where domicile is based on your intention to return to the US. However, since 6 April 2017, it is possible to acquire deemed-UK domiciled status when an individual has been resident in the UK for at least 15 out of the last 20 tax years. 

As things stand, since Jason arrived in the 2006/07 UK tax year, he will be deemed UK domiciled from 6 April 2021. With no planning in place, from this point his worldwide estate in excess of £325,000 will be subject to UK IHT.

Excluded property trust

Jason does not need all of the money within the US investment portfolio so he would like to give $2m of the funds to his children, but restrict them from withdrawing until they are 25. Jason could set up an excluded property trust before 6 April 2021 with the funds he would like to give to his children. 

For a UK domiciled individual, settlement into a trust is a chargeable inheritance tax event. Jason is however not domiciled in the UK so only his UK assets are subject to UK IHT. As the US account is non-UK based and Jason is currently not deemed domiciled, he could therefore settle the funds into a non-UK trust, creating an excluded property trust which will be outside the scope of UK IHT. The funds can therefore be passed to his children without being subject to UK IHT. 

If Jason settles $2m (£1.5m approx.) into the new trust, he could save his estate £600,000 in inheritance tax.

Working with Buzzacott, Jason would benefit from timely, practical and cost effective joined up US/UK tax advice. We also were able to refer him to a law firm to help with the legal side of setting up a will and the creation of an excluded property trust outside the UK. 

Depending on the result of the US election there could be major US tax reform. Biden has proposed lower estate tax thresholds than the above mentioned $11.58m, though he is yet to confirm the proposed new amount.  Individuals could consider estate planning while the generous $11.58m is still in existence. Given the current political uncertainty, another option that Jason could consider is the use of life insurance to pay some or all of the inheritance or estate tax bill.

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The full Stepping Stones series can be found here.