Inheritance tax (IHT) is a contentious subject for many, especially as it revolves around the sensitive topic of what happens to one’s assets after death.
For those affected, understanding the basic IHT rules is crucial.
However, the waters become muddier when considering situations involving a non-domiciled spouse.
What is Domicile?
First, let’s clarify the concept of domicile. In simple terms, your domicile is the country considered to be your ‘permanent home’.
It’s not necessarily where you currently reside or were born.
Basic IHT Rules in the UK
In the UK, IHT is levied on the estate (property, money, and possessions) of someone who has died.
The standard IHT rate is 40% on the portion of the estate valued over the tax-free threshold of £325,000.
It’s worth noting that if the deceased leaves their home to their children or grandchildren, this threshold can increase by £175,000 (known as the Residence Nil-Rate Band).
When assets are transferred between spouses or civil partners, they are generally exempt from IHT, regardless of the value.
This is called the ‘spousal exemption’.
The surviving spouse can also inherit any unused tax-free allowance from the deceased, effectively doubling the IHT threshold.
However, the rules differ when the surviving spouse is not domiciled in the UK.
IHT Implications for Non-Domiciled Spouses
When the surviving spouse isn’t UK-domiciled, the spousal exemption is limited to £325,000. Beyond this limit, IHT may be due.
For example, let’s consider a situation where a UK-domiciled individual with an estate worth £1.5 million passes away, leaving everything to their non-domiciled spouse.
The first £325,000 can be transferred without any IHT liability due to the spousal exemption.
The tax-free threshold and Residence Nil-Rate band can cover another £500,000.
However, the remaining £675,000 would be potentially liable for IHT.
Electing to be UK Domiciled
To mitigate the potential IHT impact, a non-domiciled spouse or civil partner has the option to elect to be treated as UK-domiciled for IHT purposes.
Making this election means that they can benefit from the unlimited spousal exemption.
But it’s crucial to understand that, once this election is made, their worldwide assets become liable to UK IHT upon their death.
This is a significant decision and should be made after considering all financial implications, both within the UK and in the spouse’s original domicile.
The Importance of Planning
Given these complex rules, it’s essential for mixed-domicile couples to undertake careful estate planning.
Some options might include:
- Making the election: As discussed, this could be beneficial for IHT but will bring worldwide assets into the UK tax net.
- Using the nil rate band: Assets up to £325,000 (or the prevailing threshold) can be transferred tax-free to a non-domiciled spouse.
- Gifting: Making gifts during one’s lifetime can reduce the value of the estate. But remember, there are specific rules around gifting, and if the individual dies within seven years of making a gift, it might still be liable for IHT.
- Trusts: Placing assets in trust can be another way to mitigate potential IHT liabilities.
Final Thoughts
Navigating UK Inheritance Tax rules, especially with a non-domiciled spouse, requires careful consideration and planning.
The interplay of domicile, worldwide assets, and IHT rules can be complex.
It’s always a wise move to seek expert advice to ensure your assets are passed on in the most tax-efficient manner, preserving your legacy and providing for your loved ones.
