Three ways your business could help cut your inheritance tax bill

There are 5.5 million businesses in the UK, and of these almost 80 per cent are operated by a single person with no employees.

Meanwhile, inheritance tax bills are rising. The average inheritance tax (IHT) liability was £216,000 in 2019 but is forecast to hit £266,000 in this tax year.

Yet if you run a business, or if you have a family member that does, you have the opportunity to slash your IHT bill. Here’s how.

Business relief and inheritance tax

Family businesses are often exempt from inheritance tax because of business relief. It means businesses can be passed on to relatives without having to worry about a tax bill that forces the firm to close.

You can also invest in companies and take advantage of the relief. Money invested will be free from IHT after two years if the company qualifies for business relief. So if you invest £100,000 in a qualifying firm, after two years this sum would not be liable for inheritance tax even if your total estate is above the IHT threshold. 

Which type of firms qualify for business relief?

To qualify for business relief, a company cannot be listed on a main stock exchange (although it can be listed on AIM).

Companies that have more than 50 per cent of their activities in property investment, land and buildings or stocks and shares will not qualify. 

Businesses that specialise in construction, accountancy, law, hairdressing, design, architecture, estate agency, building, hospitality, retail, manufacturing, IT and technology should all qualify for business relief. 

Nigel May, a tax partner at accountancy firm Gravita, said: “It is important to remember that relief is targeted towards ‘trading’ businesses as opposed to ‘investment’ businesses, so it is essential that consideration is given to the company’s activities as a whole. 

“Holding property and land could be viewed as an investment asset, but it depends on what it is used for. An office or factory is generally fine, but letting to other parties is generally not.”

Passing on your business to children

You may own a business and have accumulated a decent sum of cash that has not been spent or withdrawn as income. If so, you may be wondering whether the money can be passed on to your children tax-free if the business is still operating at the time of your death.

The answer could be yes in some cases. The key thing to consider is whether your company is likely to be classed as a ‘trading business’. HMRC does not state whether a company qualifies for business relief until after a person’s death and the executor of the will claims the relief. 

It is thought HMRC may be suspicious of companies that hold more than 20 per cent of the balance sheet in cash. If your business has a turnover of £100,000 but has £1m in cash it would be classed as an ‘excepted asset’ and IHT relief would not apply.

For a child looking to take over a family business, it is likely to be more tax-efficient for parents to specify in their will that the business will go to the child after their death – as opposed to children buying shares off their parents, which puts more money into the estate and may be subject to 40 per cent tax if IHT is due.

Investing in your child’s business

Let’s say you have an estate worth £5m and are looking for ways to invest this money to reduce the IHT charge after your death. Your child owns a shop and wants to expand to other parts of the UK. You could buy shares in the business, giving your child the money needed to buy more units. Once you’ve held the shares for two years, the money will be outside your estate and free of inheritance tax.

“People who are planning for inheritance tax often don’t think about investing in their child’s business. You could also invest in other businesses and get the same relief after holding the shares for two years,” says Justin King, owner of MFP Wealth Management. 

He adds: “The best IHT planning someone can do is to give excess money away as early as possible. You could invest in your child’s business either as an individual or through your own business if you have one. 

“So if you own an accountancy firm and you have a child that wants to open a restaurant, you could buy a premises through your business and bring your child in as a shareholder. This way, you are giving your child money to do something they are passionate about, and you are potentially saving on inheritance tax and diversifying your own business.”