The little-known inheritance tax loopholes that can lower your bill by thousands

Britain’s most hated tax is costing families more than ever before.

The Office for Budget Responsibility predicts that death duties will raise a record £7.2bn this year. With tax thresholds frozen until 2028, this is expected to soar to £8.4bn in five years’ time.

Inheritance tax must be paid if a person’s estate is worth more than £325,000 (the nil-rate band). For couples, this is £650,000 – with an additional allowance for homeowners pushing this to £1m if their children inherit their main property.

This barely covers the value of many homes across London and the South East that have benefitted from the huge rise in property prices over the last few decades, leading many middle-class families searching for ways to dodge the 40pc tax.

Some go to extreme lengths to protect their wealth. The Telegraph recently revealed that thousands could end up with tax bills they hoped to avoid after entering into “home loan schemes”.

But these schemes were never approved by HM Revenue and Customs. There are plenty of other schemes and loopholes out there, however, which are recognised as a legally valid way to avoid the dreaded charge.

Here, we outline five arrangements, which tax advisers have said are underutilised, that could slash your tax bill by thousands of pounds.

Family Investment Companies

Trusts are one of the best-known and most tax-efficient ways to avoid death duties, but they come with a catch.

Since 2006, any lifetime transfers into trusts have been limited by a potential inheritance tax charge. If the combined gifts to trusts in any seven years exceed the nil-rate band, then there will be a 20pc charge on the excess.

This can create issues for those with large estates. In these circumstances, a Family Investment Company may be a better option.

Ian Dyall, of Evelyn Partners, a wealth manager, said: “Rather than using trusts, a company structure can be used to hold the family wealth with different types of shares held by the parents and the children.

“Each Family Investment Company is different and advice is essential on the setting up and ongoing reporting, but they can offer a solution for transferring wealth from larger estates, while maintaining some control over who benefits and when.”

The unlimited gifting rule

Some gifts are automatically exempt from inheritance tax. The annual exemption lets you give away £3,000 each year – and £6,000 in the first.

But if you want to give away a larger sum, you will have to wait seven years before it becomes tax-free.

However, there is another, rarely used exemption that potentially allows for “unlimited gifting”. Only 430 families used it last year, but together they shielded £67m from death duties.

Gifts of any size will be automatically exempt if given out of excess income as part of “normal expenditure”.

To qualify, the gifts must come from income, not savings, and there must be a pattern to the gifting – meaning the gifts should be around the same size and paid at around the same time.

Deeds of variation

A deed of variation allows beneficiaries to change the will after death.

If you are receiving a windfall that could push the value of your estate above the nil-rate band, you can use a deed of variation to redirect that inheritance into a trust.

The deceased is seen as the donor for inheritance tax purposes, so the money will immediately leave the original beneficiary’s estate without them having to wait seven years.

This also means they can be a beneficiary of the trust without it being part of their estate.

Writing your will to unlock three nil-rate bands

Structuring wills properly can allow some married couples to claim three or even four nil-rate bands.

Since 2007, it has been possible to transfer the unused nil-rate band of a deceased partner to the surviving spouse. This must be claimed on the death of the surviving spouse.

If the surviving spouse remarries, then this couple will have three nil-rate bands between them – worth £975,000 altogether. They will have four if both were widowed.

But depending on how their wills are structured, the couple could easily miss out on this extra £325,000.

If the spouse who was widowed leaves their estate to their surviving spouse and then dies, the unused nil-rate band will disappear and the surviving partner will only be able to claim two nil-rate bands.

This means the unused nil-rate band must be used on the first death.

Mr Dyall said: “Often the best way to do this is to leave an amount of money into a discretionary trust up to the value of the nil-rate band on first death. The surviving spouse would still be able to benefit from the money in the trust, but it is not part of their estate for inheritance tax.”

Business Property Relief

It has become increasingly popular for wealthy individuals to mitigate inheritance tax by investing in shares listed on the Alternative Investment Market (AIM), which qualify for Business Property Relief. After two years the investments become free from death duties.

However, the volatility of AIM makes this a risky strategy. The market as a whole has fallen around 20pc over the past year.

A safer option, Mr Dyall said, might be to invest in BPR-qualifying companies in areas known to have lower levels of volatility, such as renewable energy or the healthcare sector.