Article Written By Adam Fayed

UK expats: your kids will probably need to pay inheritance tax if you don’t plan

Most British expats seem to assume that their children won’t have to pay inheritance tax due to the fact that they are no longer UK tax resident.

Many non-British people with UK assets assume the same.

However, there are certain inheritance tax traps that many may not be truly aware of. The burden of getting wealth as gift can sometimes outweigh the joy if you’re not cautious and lack the knowledge about how to protect against inheritance tax.

In this article, we’ll talk about top inheritance tax traps and related concerns mostly for UK expats. However, we also include certain details for other expats like in the US.

Do note that inheritance tax hullaballoos are jurisdiction-specific; meaning, what may be true in one country could be way different in another, and this article isn’t formal legal or tax advice.

Despite this, we should be able to give you some pointers to check or crosscheck against your unique situation.

Common Inheritance Tax Trap Issues

Domiciled vs Non-Domiciled

There are issues of affluent foreign nationals who live in the UK and enjoy tax breaks due to being considered non-domiciled in the country, so their profits within the territory are the only ones levied.

Such tax advantages become applicable when these expats retain their riches outside the UK. The main issue here is that locals are assessed roughly 40% taxes on income, capital gains, and inheritance no matter where those assets are. On top of that, the same levy may be imposed by Her Majesty’s Revenue & Customs even if they end up leaving the UK so long as they remain domiciled there.

British expats who are abroad for a long time may not realize this costly position. It’s one of those tax traps that someone might so easily overlook.

Generally speaking, death and the transfer of assets to a trust are the two key events that trigger IHT. If persons or their representatives like trustees or executors can prove that they have moved to a new residence before an event or action that can potentially trigger the application of Inheritance Tax, they may be eligible for an exemption.

As per UK tax rules, even three years after individuals departed from the UK, they will remain classified as domiciled in the country and will thus be subject to IHT. If one gets through this initial period, the next challenge is meeting the evidentiary standards to prove they abandoned their Domicile of Origin in the UK for a new one in their chosen place.

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Customers should get ready a signed statutory declaration showing their residency status. In the event that you ever need to assert a new domicile, this statement will provide a contemporaneous record of the facts and circumstances supporting your claim.

Domicile changes need careful planning and convincing evidence, and they can be undone if the individual ever becomes a UK tax resident again, albeit temporarily. If this is the case, returning to the UK will be seen as reviving your original domicile. Even if you remain physically present in your designated domicile throughout this time, you run the danger of HMRC taking a negative stance on this matter.

Note that if the donor spouse is UK domiciled but the surviving spouse is not, the unlimited Inheritance Tax exemption for transfers between spouses does not apply.

Also, the typical IHT tax rate may be imposed on the value of the transfer if a British expat who is regarded UK domiciled passes away and leaves significant fortune to a non-British spouse.

Double Taxation

Since CGT and IHT are two separate levies, it is possible for the same property to be subject to both. Lifetime transfers of assets may trigger capital gains tax liability in the same manner as a sale. Gifts are subject to CGT, and the taxable gain is determined by taking the current market value of the gift and subtracting the cost from the donor’s initial cost.

UK Properties

Investors in stocks and real estate, who may have seen their holdings appreciate significantly, are hit particularly hard. You should know that CGT often does not apply to your primary residence.

Gifts to a spouse are not subject to capital gains tax, but gifts to children or non-martial partners may be. This can catch people off guard when they separate from an unmarried partner and divide assets between them.

Donating property in the last seven years of your life could subject your heirs to an inheritance tax obligation. The gifted assets within that window will be counted under your estate and will thus be subject to IHT.

Nevertheless, many persons can reduce the amount of IHT owing by using exemptions and allowances, such as the one for their primary property.

If you can prove that you were not financially dependent on the money, your heirs may be able to avoid paying inheritance tax by receiving gifts from your regular income instead.

Higher Inheritance Taxes

When an individual has numerous assets in separate countries, the same properties may be subject to inheritance tax in all those countries.

Estate tax exemption levels, above which the tax no longer applies, might vary by country. Overspending on inheritance taxes is possible if the total amount of your assets is beyond the applicable thresholds in more than one jurisdiction.

How to Protect Against Inheritance Tax

What will cushion your susceptibility to inheritance tax traps will vary depending on the assets you’re actually receiving. Below are some other pitfalls and ways to avoid or reduce the supposed IHT.

Some people who inherit a retirement account like 401(k) or an IRA make the error of withdrawing the money without considering the consequences. Income taxes at the federal and state levels have not yet been paid if the inheritance money comes from a retirement account to which tax-deferred contributions were made.

Any money you take out of an inherited account counts as income and must be reported. Which implies you can pay more in taxes than you expected and have less money left over.

You can avoid paying IHT if you get a payout from a Roth 401(k) or IRA. Both of these accounts are funded with after-tax dollars.

You can choose to keep a regular or Roth 401(k) intact or transfer the funds to an inherited IRA. You can avoid feeling rushed into spending the inheritance this way. Instead, once you reach age 72, you’ll only need to withdraw the legally mandated minimum from your retirement savings each year, known as the minimum distribution. This tactic can assist you avoid having to pay excessive taxes all at once on the money you inherited by spreading them out over the course of your lifetime.

You should be aware that the tax regulations apply differently to mutual funds and equities that you inherit in taxable accounts, such as brokerage accounts under your name, than they do in other situations.

When calculating the value of an estate, the adjusted cost basis is commonly used. This means that what the assets would have been worth in the open market on the day of the passing of the previous owner is considered.

Should you decide to offload the assets you inherited, you may be subject to capital gains or losses due to the reset cost basis. A final figure must be determined based on the asset’s market worth. Remember that capital losses can assist reduce your taxable income and the aggregate amount owed in taxes, but capital gains have the reverse impact. Gains on investments can boost annual salary and, thus, tax liability.

For the most part, the tax treatment of mutual funds and stocks in taxable accounts is different upon inheritance. Any profits made from selling the item could increase or decrease your taxable income. This is because the value is calculated using the stepped-up cost basis.

In the United Kingdom, the payout of a life insurance policy is not levied, albeit the inheritance tax may be assessed in certain circumstances.

This is the case when the value of the estate left by the deceased, including the proceeds from the life insurance policy, is greater than the IHT limit. The threshold per individual now stands at 325,000 pounds.

By establishing a trust, you can transfer property to your heirs in advance of your death without including the funds in your inheritance. The full amount of a life insurance payout is dispersed to beneficiaries without going through probate or triggering any taxes when it is put into a trust instead of an individual’s estate.

To reduce the impact of a hefty estate tax, another strategy is to assign assets to a foreign holding company. This method is complex and expensive, though. Furthermore, it may have unexpected tax consequences in the country where the foreign entity is incorporated. Important personal assets, such as a primary dwelling, may not be good candidates for this approach.

In terms of debts, a deceased person’s family members may be pursued by creditors for payment of what the deceased owes. However, you must realize that the deceased’s estate, and not you personally, is responsible for paying these claims. In most cases, inheritors are released from liability for the deceased’s financial obligations.

A decedent’s liabilities do not magically vanish when they pass away. If the estate of the deceased individual has enough money, it is legally compelled to pay off any outstanding debts. Inherited wealth may be diminished by this factor to varied degrees.

Conclusion

If you don’t have many assets to give away and are therefore below the inheritance tax threshold, then you will probably be OK.

Moreover, let me reiterate that inheritance tax traps can be quite complex and differ for every territory. Knowing when to execute an asset transfer or sale can be a useful strategy. And while holding multiple properties across different nations could be a hidden trap, don’t forget that there are countries with no inheritance taxes and with simpler tax systems overall. These are further things to consider.

What can help you navigate all these is careful financial planning with a dependable financial advisor or tax expert.

If you are interested in protecting yourself from this issue, please contact me via email – [email protected]

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About the Author(Adam Fayed)

Hailing from the UK, I assist expats and high-net-worth individuals in over 100 countries, streamlining processes through online solutions to save time, money, and hassle. With a significant online presence, I am a published author on Amazon and have a substantial readership of ten million across various platforms, including Forbes. Additionally, I am recognized as the most viewed financial writer on Quora.com, accumulating 500 million lifetime views.

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UK expats: your kids will probably need to pay inheritance tax if you don’t plan