Many Americans living in the UK are considered to be non-domiciled for UK inheritance tax purposes. Currently, a non-domiciled individual becomes deemed domicile for inheritance tax purposes when they have been resident in the UK for 17 out of the last 20 years. This threshold is set to change to 15 out of the last 20 years in April 2017. When an individual is deemed domicile for UK inheritance tax purposes, the UK will generally apply its inheritance tax rules on an individual’s worldwide assets.
Until an American meets the UK deemed domicile rules, it is likely that they will be considered non-domiciled in the UK and any assets held outside of the UK generally remain outside of the UK inheritance tax net. And, following the changes that are set to come into effect in April 2017, once an individual is over the threshold for being considered deemed domicile in the UK for inheritance tax purposes, they will need to leave the UK for a period of at least 6 years before their UK deemed domicile status will cease.
Given the modest thresholds present in the UK for inheritance tax, in the lead up to becoming deemed domicile, it becomes especially important to review the planning opportunities available. One option open to non-domiciled individuals prior to becoming deemed domicile in the UK is the ability to fund an excluded property trust for assets that are held outside of the UK. Generally any assets held within this type of trust, while remaining offshore, will be excluded from UK inheritance tax even after becoming deemed domicile. For some this could be a way to equalise the differential between the US and the UK inheritance tax bands. A simplified example is probably the easiest way to illustrate potential savings:
Let us assume an individual with a total estate worth $6 million held in the US. To keep round numbers, let us also assume the UK threshold of £325,000 equates to $500,000. Therefore $5.5 million of assets would potentially be subject to a 40% inheritance tax once the individual becomes deemed domicile in the UK. Under UK rules, the $6 million estate will pay inheritance tax of $2.2 million. Under US rules, the $6 million estate will pay $228,000 in inheritance tax. If this individual funds an excluded property trust with $4.93 million ($5.43 million US lifetime allowance less the $500,000 UK nil rate band) then the estate tax bill as a UK domicile individual will now be equal to what the US estate tax bill would have otherwise been ($228,000). That results in a potential inheritance tax savings of nearly $2 million!
The opportunity to fund an excluded property trust ceases when the deemed domicile threshold has been crossed. So, what else can be done? Developing a lifetime gifting strategy remains a viable option provided the requisite seven years has been outlived, to be considered an exempt transfer. For some people a strategy of passing on wealth during their lifetime may be a very effective way to meet long-term priorities and objectives. It is essential to work with an adviser to put together an appropriate and individual strategy as everyone has differing needs and requirements. Additionally, an adviser can help determine the best way to go about implementing the lifetime transfer of wealth. What will remain of utmost importance, is understanding precisely when the rules will begin to apply and take any relevant action appropriately.
For more wealth planning tips and tidbits from MASECO read our 39 Steps to Smart Living in the UK.
Risk Warnings and Important Information
The above article does not take into account the specific goals or requirements of individual users. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.
MASECO LLP trading as MASECO Private Wealth is authorised and regulated by the Financial Conduct Authority, the Financial Conduct Authority does not regulate tax advice. MASECO Private Wealth is not a tax specialist. We strongly recommend that every client seeks their own tax advice prior to acting on any of the strategies described in this document.