Complications and potential IHT liability arising with a discretionary family trust

Our clients, the executors of their father’s estate, were faced with complicated probate issues and potential significant inheritance tax liabilities arising from assets being in a Family Trust created many years ago into which their parents had gifted the family home.

The factual background was quite complex :-

• Our client’s parents gifted the family home into the Trust and continued living in it until our clients’ mother died.

• Shortly after her death the bereaved husband moved out of the Trust property, which was subsequently sold. He moved into a new home that had been purchased by him and his wife before her death. He remained living there until his own death.

• Our client’s father later replaced his predeceased wife with one of his children as a new Trustee. He also remained as a Trustee of the Family Trust along with his children.

• After this he transferred the title of his new home into his and his children’s names. He did not obtain legal advice on what else, if anything, he could have done to preserve the new family home for his children while protecting the asset from future Inheritance Tax.

• When our client’s father died the estate faced a potential £100,000.00 inheritance tax bill.

Our clients were unaware of the advice received by their parents on the creation of the Family Trust or of the potential negative consequences that it could pose for Inheritance Tax when both parents died. This is a frequent scenario that we have to bring to your attention as it can save your family thousands of pounds in Inheritance Tax. It can also prevent a delay in the application for a Grant of Representation (Probate). Challenges

The greatest challenge we encountered was establishing the facts due to a lack of documents proving the trajectory of the Family Trust, from its inception all the way through to the death of our client’s father. We had to rely on our clients’ memory and on their work to unearth pieces of evidence that could put our case together. This really highlighted how important it is for the Trustees of any Trust to document every decision and step taken during the administration of a Trust and to keep all documents together in a safe place.

We also had difficulties in confirming the exact position of the husband’s estate for Inheritance Tax purposes. We pondered over whether it was taxable or not? If it was taxable, how much Inheritance Tax should the estate pay? There were various scenarios and potential outcomes. We moved past the first impression that the estate might have to pay Inheritance Tax.

We spent time building a coherent case that we could piece together and presenting it to HM Revenue & Customs (HMRC) in a way that could be understood and agreed upon by them.

Our approach

Key issues included :-

• Determining who owned their father’s home and whether there was a latent ‘gift with reservation’ in their father’s share of their parents’ first home. The latter had been expressly gifted by them into the Family Trust many years ago.

• Examining and applying the rules surrounding ‘gifts with reservation’ to the facts . These rules are too frequently overlooked by families when creating Family Trusts into which they gift their home. They apply when someone gifts away an asset, like their home, but continue living in it for the rest of their life. HMRC says that the gift does not count, even if 7 years have passed since the house was gifted into the said Trust. Regardless of the Trust arrangement the value of asset gifted into the Trust can be liable to Inheritance Tax.

We built up several scenarios with each of them having a different outcome regarding the Inheritance Tax (IHT) potentially due by the estate. From not having to pay any IHT to an IHT bill exceeding £100,000, depending on how we looked at the facts.

We were very meticulous in the way we completed the Inheritance Tax Account.

Impact

We were successful in our recount of the facts to HMRC which, together with the evidence provided, exempted our clients’ estate from the payment of any Inheritance Tax on their father’s estate. We saved our clients circa £100,000 in Inheritance Tax.

This case highlighted the importance of the use of a legal advisor not only when a Family Trust is created but also throughout the duration of the Trust. This can save families considerable stress, time and Inheritance Tax.

If you have a Family Trust or are thinking about setting one up our specialist Private Client legal team can help. Please do not hesitate to book a complimentary initial consultation with one of them.