Tax Talk: Inheritance Tax and the modern family

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With Inheritance Tax (IHT) thresholds frozen by the Treasury until 2025/26, now is a good time to consider IHT planning and to update your will. Andrew McCready explains some of the complications that may arise for LGBTQ+ families and couples not in a legal partnership.

Benjamin Franklin’s much quoted words, “in this world nothing [can be] certain, except death and taxes,” could have been so apt for Inheritance Tax (IHT). Except that IHT is both a death and a life tax, as it can also be charged on certain transactions during an individual’s lifetime.

The Office for Budget Responsibility (OBR) expects IHT to raise £6.7 billion for the Treasury in 2022/23. Now that IHT thresholds have been frozen until 2025/26, we can expect that number to keep rising.

It’s estimated that 31 million adults in the UK have not made a valid will. If you are one of these, and the worst happens, your estate may unintentionally suffer an IHT liability, and your assets may not pass to your chosen heirs.

If you are part of an LGBTQ+ family, IHT planning and drafting a will can be even more complicated. Although sexuality and gender identity, per se, are unlikely to be a key consideration when tax planning, there are some fundamental issues to consider.

Same-sex spouses and civil partners

Same-sex spouses and civil partners are eligible for the same IHT exemptions and reliefs given to opposite-sex spouses and civil partners. Generally, on death, assets transferred to a spouse or civil partner are exempt from IHT at an unlimited value. The exception is where the estate passes from a UK-domiciled spouse or civil partner to a non-UK domiciled one. In this case, the exemption is limited to the available nil-rate band (NRB) and the spousal exemption of up to £325,000 each (unless you have made an IHT domicile election).

Similarly, where a residence that was once a spouse or civil partner’s main residence is passed to a qualifying lineal descendent, they can benefit from the Residence Nil-Rate Band (RNRB) of up to £175,000 per spouse. Any unused NRB and RNRB on the first spouse or civil partner’s death may be transferred to the surviving spouse or civil partner.

Same-sex spouses and civil partners also enjoy the same right to inherit a certain proportion of their partner’s estate if they die, without making a will under the rules of intestacy.

Co-habiting families

Co-habiting families and couples who are not married or in a civil partnership cannot benefit from the unlimited spousal exemption. Any unused NRB and RNRB cannot be transferred on death to the surviving partner. This applies for both same-sex and opposite-sex partners.

A House of Commons briefing paper, Common law marriage and cohabitation (House of Commons Library, 4 May 2021) estimated that around 46% of same-sex couples in families were co-habiting in 2020 as opposed to 21% of opposite-sex couples in families. This means that LGBTQ+ families are likely to be disproportionately affected by the lack of reliefs for co-habiting couples and families.

If there is no will, partners are not automatically entitled to receive an interest in their deceased partner’s estate. This means it’s especially important for co-habiting families to make a valid will.

As for the RNRB, a scenario may arise if a couple with children are co-habiting. As an example, Alex is the legal parent of the children, but Geoff has no parental responsibility or guardianship for them, nor does he have children of his own. If Geoff died before Alex and left his former main residence to Alex’s children, Geoff’s estate would not benefit from the RNRB when calculating the IHT due on his estate. This is because, although Geoff has lived with Alex for several years and considers the children his own, legally he does not have parental rights or guardianship over them. This means they are not considered his lineal descendants for the purposes of the RNRB.

This creates a potential problem for couples with children where one party is not a legal parent or guardian, even if they in practice act as the child’s parent. Both LGBTQ+ and non-LGBTQ+ couples with children should understand the implications and consider acquiring joint legal responsibility for the children as an appropriate tax planning step.

Same-sex parents and their child’s domicile

Domicile is a common law concept that has been imported into the UK’s tax system to determine an individual’s liability to Income Tax, Capital Gains Tax and IHT. Please see Phil Clayton’s article, When domicile doesn’t translate to residency, for an explanation on domicile.

In general terms, on an individual’s death, if they have a UK domicile their worldwide estate is liable to UK IHT. But if the individual has a non-UK domicile, only the estate’s UK-situs assets are liable.

Every child is assigned a domicile of origin at birth. It will remain with them for life, unless it’s displaced by a domicile of choice or domicile of dependency. A legitimate child’s domicile of origin (where a child is born to or adopted by parents who are legally married or in a civil partnership) is generally acquired from their father. An illegitimate child generally takes theirs from their mother. The position becomes more complicated where a legitimate child has same-sex parents.

Under current law in England and Wales, a legitimate child’s domicile of origin may not be determined if they have two mothers or two fathers. This is because their domicile cannot be acquired from both parents. In practice, this is only an issue if the parents have different domiciles.

This issue has yet to be tested in a court. Determining a child’s domicile would ultimately come down to the facts of each case but could have far-reaching ramifications for the child. It is clear the current law does not consider LGBTQ+ parents and their children and without genuine reform, it’s only a matter of time before these cases end up in court.

Wills and transgender family members

Since the introduction of the Gender Recognition Act 2004, people have been able to legally change their gender recorded at birth. The reassignment of an individual’s gender can create difficulties regarding a person’s will.

The Act came into force on 4 April 2005 and does not apply retrospectively. This means that wills written earlier will not recognise a person’s new gender identity. For example, James and Sarah had two sons, Harry and Callum, and two daughters, Lucy and Emily. James and Sarah made mirror wills before 4 April 2005 leaving 50% of their estate equally between their sons and 50% equally between their daughters.

Several years later, Harry transitioned from male to female and changed name to Harriet subsequently obtaining a gender recognition certificate legally changing gender.

As James and Sarah made their wills before 4 April 2005, Harriet would continue to be entitled to a share of the estate allocated to the sons, as before, because the change of gender would not be recognised.

But if James and Sarah had made their wills after 4 April 2005, their estate would pass to the beneficiaries in accordance with Harriet’s legal gender. Therefore, 50% would pass to Callum and 50% would pass equally to Lucy, Emily and Harriet.

It’s clear this was not the original intention of the will. The beneficiaries could apply to the courts to try to alter the distribution of the estate. Failing that, they may enter into a Deed of Variation to alter the will and distribute it as was originally intended.

Regular updating of wills to reflect a beneficiary’s change of gender is therefore important to avoid this confusion. Alternatively, it is recommended you use gender-neutral expressions such as “my child” or name the beneficiaries so it can be linked back to the intended recipient.

It’s clear that the UK’s tax system does not adequately address the differences in today’s modern families. Current legislation has failed to keep up-to-date with society, directly and indirectly excluding LGBTQ+ families and individuals who are not married or in a civil partnership. Perhaps lawmakers should start considering how best to make our tax system inclusive for all.

For more information about the issues raised in this article, please contact Andrew McCready.