YOUR MONEY Q&A: How inheritance tax affects you

A new feature begins with a look at one of the Chancellor's concessions to Middle Britain
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The Independent Online
"Inheritance is now an issue for middle Britain," declared Kenneth Clarke in his Budget speech, saying he wanted to abolish inheritance tax as soon as that could be afforded.

Q: What is all the noise about inheritance tax?

A: John Major recently said he wanted to see the tax, which is levied on the estates of the dead, abolished. The Budget took the lesser step of just increasing the threshold at which the tax bites. Trouble is, even this improvement is being knocked because it does not take effect until the next tax year in April.

Q: But isn't inheritance tax just for the rich?

A: You might think inheritance tax is a minority taste, but it also hits the "middle Britain" that Mr Clarke went on about in the Budget. It bites on estates worth more than pounds 154,000 at a rate of 40 per cent. Importantly, this figure includes the value of the family home. People with relatively modest homes in areas of high property values could be at risk, especially if they have several thousands pounds in savings.

Q: So what did the Budget do?

A: The Chancellor chose not to abolish inheritance tax. In the next tax year it is expected to raise about pounds 1.5bn - equivalent to more than the 1p cut in basic-rate income tax - but he increased the tax-free threshold from pounds 154,000 to pounds 200,000. Estates worth less than the threshold escape the tax and the increase in the threshold should save estates of pounds 200,000 or more pounds 18,400.

Q: How many are affected?

A: The number of estates on which the tax will be levied in the 1996- 7 tax year is likely to be around 15,000; 7,500 having escaped thanks to the increase in the threshold. That is about 1 in 45 estates, compared with 1 in 30 in the current tax year. But an unknown number of people will use accountants and tax planners to minimise or remove any post- death tax bill.

Q: So it is easy to avoid this tax?

A: People with serious wealth can transfer it out of their potentially taxable estate, by giving things away at least seven years before they die, by setting up trusts, by diverting money to shares in unquoted companies (which escape the tax) and so on. But for those who have high-value homes and modest life savings, room for manoeuvre is limited.

Q: Can't people simply give away their homes?

A: This is riddled with pitfalls. Let us say you "give" your home to a trusted son or daughter. First, you will have to satisfy the tax authorities that the gift is genuine You will have to pay your new landlord a proper market rent. That is more expense for you, and your new landlord would have to pay income tax on the rent. He or she could also face a capital gains tax bill when the property is eventually sold. And if you were to die within seven years of making the gift, there could still be an inheritance tax bill, too. There are other complications. What would happen if you fell out with your new landlord? What would happen if he or she actually died before you? Giving away your home can be messy.

Q: That sounds worrying. What happens to my estate if I leave everything to my husband or wife?

A: There are no problems here. As well as the nil-rate tax band, there are some gifts that are exempt from inheritance tax and do not even count towards the nil-rate band. Crucially, this includes anything you leave your husband or wife. But the exemption will not cover you if you are not married. As a consequence, the exemption can never cover same-sex partners.

Q: Any other suggestions?

A: The surest way to see your heirs do not pay the tax is to leave them nothing. Spend, spend, spend while still breathing.

Q: Don't people like to leave something to their families?

A: Apparently so. Indeed the issue is being taken up by some politicians as if it were some inalienable human right. It is an unusual departure. A belief in a meritocratic society and an instinctive distaste for inherited wealth is fairly widespread, and not the preserve of those who used to be called socialists. In any case, the inheritors of middle-class wealth are most likely in their thirties, forties or fifties and financially well-established.

Q: Those socialists, are they still around?

A: Try asking Tony Blair or Gordon Brown, his shadow Chancellor. We can be sure that Labour is against the abolition of inheritance tax and is likely to eliminate the loopholes that allow the super-rich to avoid it. However, the betting is that even Mr Brown could well move the inheritance tax threshold even higher.

q Questions and answers compiled by Anthony Bailey.