Louise McBride: The taxman has his eyes on your inheritance - and it could get worse
More of us are getting stung for inheritance tax - and it could get worse, writes Louise McBride
The inheritance tax take has almost doubled in the last five years - and with moves afoot to tighten up the rules around this death tax, more people could get caught for it in the coming years.
Finance Minister Michael Noonan is currently examining the rules around a popular tax relief which allows houses and apartments to be inherited tax-free. The relief - known as the dwelling house exemption - has increased in popularity in recent years and sparked concerns that it is being abused.
Last year, about 741 people claimed the dwelling house exemption - up from almost 500 in 2012. The rules around this relief may well be tightened to restrict the numbers of people using it.
"My department - and the Revenue Commissioners - have encountered some evidence that individuals may be using the relief as a way of passing on wealth tax-free in a manner which is not in line with the core aim of the relief," said Noonan in response to a parliamentary question during the summer.
"We are currently working to gather and assess information relating to such possible practices and to consider whether the current scope of the relief is in line with its original spirit. The underlying purpose of the relief, which I consider to be reasonable, is to prevent so far as possible cases of hardship arising from a tax perspective - when a person is gifted or inherits what is, in effect, their home."
The dwelling house exemption is probably the only way which a valuable family home can be passed on to one child tax-free. The property being passed on doesn't have to be a family home - it could be a second property or holiday home. Neither does it have to passed onto a relative.
As long as the person inheriting the property has been living in the property for at least three years - and continues to live there for six years after inheriting it, he should qualify for the exemption and so inherit it tax-free (provided some other conditions are met).
When asked by the Sunday Independent if the rules for the dwelling house exemption could be tightened in the upcoming Budget or Finance Bill, a spokeswoman for the Department of Finance said she could not comment on any changes that might be made in the Budget. "As with all other areas of tax, inheritance tax is kept under regular review as part of the annual Budget and Finance Bill process," she said.
It's anyone's guess when Noonan might make any changes to the rules around the dwelling house exemption. The review of the relief might see Noonan limit the extent to which children can use it to inherit a house tax-free, according to Michael Gaffney, a tax expert with KPMG.
"The law around the exemption as written is not complicated and if certain basic conditions are met, a house can be transferred to any person who has lived in it for three years," says Gaffney. "It's hard to see how someone who meets the simple conditions of the law is abusing it.
"The problem may be that when the law was introduced, one of the situations it was said to address was where elderly brothers or sisters lived together and eventually one inherited the family home from the other. However, when the law was written and passed, it contained a more general exemption (rather than one which was restricted to siblings)."
The law could therefore be changed to restrict the use of the exemption to certain people, properties, or circumstances.
It is less than two years since Noonan tightened up other rules around inheritance tax, which have made it more difficult for adult children to get tax-free digouts from their parents.
The increased scrutiny of, and tinkering with, inheritance tax rules makes it even more important to understand the rules of any inheritance tax relief you claim - and to ensure you qualify for such relief. Otherwise you could face a crippling tax bill - and, if you have incorrectly claimed a relief, penalties.
So where are people getting caught out most when it comes to inheritance tax?
Dwelling house exemption
"People often get caught out because they get a gift of a house and claim the dwelling house exemption - but they haven't met all the conditions," says Gaffney.
"For example, the person who receives the house must not have any ownership interest in any dwelling house at the date of the gift. A dwelling house includes houses or apartments which are rented out. So, for instance, if a parent gifts a house to a child, but that child owns, say, a quarter share of an apartment which is rented out, the child cannot get the exemption."
Even if you get your child off the hook for inheritance tax when passing on a property under the dwelling house exemption, you could trigger a capital gains tax (CGT, a tax paid on the sale or disposal of assets) bill for yourself. "Occasionally, I see parents triggering a CGT bill for themselves here because they're disposing of an asset which has increased in value since they acquired it," says Oonagh Casey-Grehan, partner with Fagan & Partners.
Digouts for adult kids
Before December 2014, parents could pay for the support, maintenance or education of their children without triggering a tax bill for their child - regardless of how old that child was.
However, in December 2014, the Government tightened up the law around inheritance tax so that only children under the age of 18, or those in full-time education and not more than 25 years of age, are exempt from tax on such financial support.
"Many parents believe that it's no problem to provide for a child financially if the child is over 25 and studying," says Casey-Grehan. "Quite often, you have children leaving school at the age of 19. They may go on and do a four-year course - followed by a masters - or they may do a seven-year degree in medicine."
Such children could still be getting some financial support from their parents when they're older than 25. "Once a child over 25 gets more than €3,000 a year from each of his parents [€6,000 in total], a tax bill could be triggered for the child in the future," says Casey-Grehan.
"You could be paying their tuition fees for example. If the child is living away from home and renting somewhere, you may be paying their rent. You may be providing them with money to cover food, transport, college books and so on. You might be providing them with free use of a second home." All of these things could trigger a tax bill for an adult child.
The family business
When passing on a family business, a tax break known as business relief can slash the inheritance tax bill - as long as the rules are played by.
"When a family business, usually in a company, is passed to the next generation, you can have some bad surprises," says Gaffney.
"The gift or inheritance tax should be low - around 3.3pc or less - due to the business relief tax break. However, there are detailed rules to be met. For instance where there are assets in the company, such as investments, which are not needed for the business, the tax on these will be up to 33pc. This includes cash.
"I have seen many cases where individuals genuinely feel that the business needs to hold a certain level of cash, so that the cash should be seen as part of the business - and not taxed at the higher rates. However, if this is disputed it can be hard to prove the individual's case, and if the dispute goes to the courts, that is a lengthy and expensive process."
Light at the end of the tunnel?
Inheritance tax bills have forced many children to sell the family home. The current government has promised to make it easier for children to inherit the family home tax-free by increasing their tax-free thresholds (the amount of wealth they can inherit tax-free).
At €280,000, the current tax-free threshold for children is very low - particularly if the inheritance includes a home in Dublin or in a valuable country estate. That threshold, will eventually be increased to €500,000 - if the government lives up to its promise. Most tax experts expect the threshold to be increased further in next month's Budget, though not by a huge amount.
Any increase in the thresholds will be welcome - but not if a tightening of inheritance tax rules undoes any easing of the burden of death taxes on Irish families.
The 60-second guide to... chopping your children's inheritance tax bill
Stick within inheritance tax thresholds, which allow relatives and others to inherit a certain amount of wealth from you tax-free over their lifetime. Doing so could eliminate inheritance tax entirely for those to whom your leave your estate. A son or daughter can get up to €280,000 over their lifetime tax-free; a brother, sister, niece, nephew or grandchild can get up to €30,150; an in-law, friend or stranger can get up to €15,075.
Make full use of the tax-free thresholds by passing on your inheritance to your extended family, rather than restricting it your children. "If leaving an inheritance to three of your own children (and) those three children are married and have children of their own, pass on some of your inheritance to your grandchildren and in-laws so you can use up all of your tax-free thresholds," says Oonagh Casey Grehan of Fagan & Partners.
For example, let's say your son is married and has two children. Rather than leaving €350,000 to your son and triggering a tax bill in doing so (because the inheritance is over his €280,000 tax-free threshold), you could eliminate the tax bill altogether by leaving €30,150 to each of his two children, €9,700 to his wife and €280,000 to your son.
Get up to speed on any exemptions which might get a child off the hook for inheritance tax, such as the small gift exemption (which allows a child to get €6,000 worth of tax-free gifts from his parents a year) and the dwelling house exemption.
"The conditions to be met for retirement relief are different to the conditions which must be met for business relief," says Michael Gaffney of KPMG. So hire a tax advisor if passing on a family business - then you can take full advantage of retirement and business relief.
Sunday Indo Business