Toastmasters "FATCA" Project

This page isn't live yet, but it is where I intend to post the video of my Toastmasters "FATCA" Project, due to be given at the Cardiff Toastmasters on 3rd October 2018.

In the meantime, here are a few resources:

FATCA on Wikipedia

FATCA on the US Internal Revenue Service Website

FATCA (and other AEOI agreements) on the UK HM Revenue and Customs website

FATCA guidance from STEP and flowchart (both PDF)

Hugh James (Solicitors) Blogs on FATCA by Andrew Jones:
FATCA: Trustees must take urgent action
FATCA – Where Do Trustees Stand Now?
Are you an American taxpayer but don’t know it?
What does FATCA mean for real people?

Is a Complicated Will Better Than a Simple Will?

A potential client rang me with this fascinating question recently, having been advised by someone else to have a complicated will, and wanting a second opinion. Is a complicated will better than a simple will? 

To be more specific, he and his wife had been advised to have the kind of complicated will comprising two different types of trusts which I have blogged about before: see the ending of this posting. And he wanted to know whether that was better than simple wills which basically left everything to the survivor outright, failing which everything to the children equally, failing which grandchildren.

I suppose we need to start by asking what would make one will "better" than another. Clearly neither will could be described as better if it didn't achieve the client's objectives. So probably being better has to be defined in terms of whether it saves inheritance tax or not, and if so whether the saving would justify the other costs and consequences.

I'd also start from the position, which I feel sure most of my clients would agree with, that other things being equal, simple is better. Because it just is.

So the question turns, for me:

Firstly, on whether the client has a tax problem at all: married couples with estates below £650,000, for example, are almost certainly better served by a simple will.

Secondly, on whether the client has, or might have, assets which would be tax free on the first death, even if left to someone other than a spouse. Business assets, agricultural assets, substantial pension schemes and tax-efficient investments (such as AIM or EIS). In the absence of those, I'd say the simpler will still has the edge.

It does also raise the question (which I will save for another post) of the non-tax advantages of trusts.

Inheritance Tax Strategy 9 - Sort Out Your Pension

Most people have pensions for reasons unconnected to Inheritance Tax ("IHT"). Indeed, the whole concept of “a pension” is completely unrelated to the idea of you dying and passing on your wealth. Just the opposite: pensions exist to provide you with an income in retirement, for as long as you live, and then (traditionally) they stop.

Over the years, that has changed: and especially since the so-called A-Day (6^th April 2006, the date on which “pensions simplification” came into effect) pensions have become regarded as a fairly flexible form of investment.

There are two circumstances in which a pension fund will pay out a lump sum on the member’s death:

1.           Death in service: this is often a fixed sum (sometimes, in occupational pension schemes, related to the member’s salary) and usually in addition includes a return of the member’s contributions plus growth.

2.           The balance of the fund after retirement: unless and until the fund is annuitised (explained below) then the balance of the fund, less any income already “drawn-down” and less any tax payable on the death, is paid out as a lump sum.

A pension which is annuitised in the traditional way (i.e. the fund is cashed-in to buy an annuity which pays a monthly income to the member (and widow(er), if relevant) until death) ceases to be of interest to us from an IHT-planning viewpoint. That is because there will be nothing left at the death to tax-plan with. The person who wins most from annuitising his or her pension is the member who lives for many more years than expected and keeps drawing the income. The person who loses most is the heir of a member who dies very shortly after annuitising: who gets nothing.

So, where does inheritance tax come in? The answer is that these lump sums paid out of pension schemes are IHT free, provided that the pension fund trustees pay out the fund at their discretion, and not to the member’s estate. (So it is important to check that the fund is set up in this way, although most are. It is also important to “nominate” your pension – that is, to tell the scheme’s trustees who to pay the money to, if the worst happens.)

You may be asking ‘if there’s no inheritance tax, why did you say “...less any tax payable...” in item 2 above?’ Good question. The answer is that when a member takes a pension draw-down (which means that he or she didn’t annuitise the pension fund, but instead left the fund intact and drew an income from it) he or she suffers income tax at 55% on the balance left in the fund at death.

So far, you may be thinking, so good. We’ve had the problem with the income tax but, that aside, everything seems positive. Certainly there are no IHT problems – on the contrary, it’s all IHT free. And you would be right. But any tax advantage is also a threat: the threat that you might fail to take advantage of it. In this case, for example, what you might have done (in fact, I bet you did!) is to nominate your spouse as the recipient of your pension lump sums. And gifts to spouses are IHT-free anyway. So we’re back to the problem, mentioned a before on my blog, of having used two tax reliefs where one would have done, and of bunching everything into the estate of the survivor: an estate where it won’t be a pension fund any more, just a wodge of cash to be taxed at 40% when the second death comes. And especially if it suffered the 55% tax before the survivor received it, paying a further 40% on the same money again is just adding insult to injury.

So what do we do?

If you are in drawdown, your widow(er) could just stay in drawdown.

The best answer is that you put the death benefits into a discretionary trust. (There are two ways of doing this: you either “nominate” a discretionary trust in your will to be the recipient, or you actually “settle” your pension schemes onto one or more trusts in your lifetime. The bigger the pot, the greater the advantage of the second method.) The reason this works is the same as for the other first-death discretionary trusts we have mentioned. The survivor has access to the pot if needed, because the trustees have discretion to provide funds to him or her. But the pot doesn’t belong to the survivor (it is “not in the survivor’s tax estate” as we lawyers put it) and therefore is not taxed on his or her death.

Inheritance Tax Strategy 8 - Tax Planning in Wills

First Death Discretionary Trusts

I have blogged on this subject before (here), and if you are new to the subject I'd recommend starting with that posting and then coming back here. Below, I explore some of the same ideas, in a bit more detail.

If you are a couple, then you get a problem known as “bunching”. The first of you dies, leaving everything to the survivor. The survivor then has all the assets bunched into his or her tax estate, and is comparatively richer, and therefore more exposed to inheritance tax. A better approach is for whichever of the couple dies first to give away any items which will be tax free on that first death.

If the couple can’t afford to give away the assets in question outright (for example to the children), a good approach is to create a discretionary trust, in the will itself, the terms of which are that the survivor can benefit from it if need be. The trust’s job is to take assets which would otherwise have been inherited by the survivor, and instead hold them in a kind of “cocoon” where they do not belong to the survivor, but can be made available to the survivor if he or she has need of them. It is important that only non-taxable assets go into them, however, since the trust itself is a taxable beneficiary: if you inadvertently leave a taxable asset to it, you pay 40% tax, unnecessarily, on the first death.

Under the old (pre-2008) rules, trusts of this kind were very popular in wills, where they were usually called “nil-band discretionary trusts”. So, if you have one in your wills already, the big decision is whether to keep it, or to simplify the wills by removing it (i.e. simply leaving everything to each other on the first death). My advice to clients on this point is that you don’t need to remove it. It does no harm as it is, at least from a tax viewpoint, because when the first death comes the trustees can decide at that time either to implement the trust, or simply to wind it up in favour of the survivor.

The points to consider are:

a. First death discretionary trusts are only there for married couples and civil partners. If you are single, widowed or divorced they are not for you. (But this doesn’t mean, necessarily, that I wouldn’t advise you to have a discretionary trust in your will for some other reason.)

b. You no longer need one of these trusts to take advantage of two nil-bands, so a married couple (or civil partners) with total wealth below two nil bands (2 x £325,000 = £650,000) really no longer have an inheritance-tax problem. Therefore if you are in that bracket, you can ignore (c), (d) and (e) below.

c. You do need a first death discretionary trust if your wealth includes:

              i.            APR assets (see Strategy 7);

              ii.           BPR assets (see Strategy 6); or

              iii.          a pension fund (which I'll discuss in a future blog).

              As you might expect, the bigger the size of your IHT problem, and the bigger the size of those assets, the more worthwhile a first-death discretionary trust is.

              Alternatively, you can achieve the same tax effect by doing anything else which gets rid of the non-taxables on the first death (such as outright legacies to children or grandchildren).

d. You do need a first death discretionary trust, also, if you or your spouse (or both) have been widowed in the past. In that case, clever use of the discretionary trust can allow you to claim not just your own two nil-bands but ALSO the nil-band(s) of your former spouse(s).

e. In the case of pensions, one or more trusts created in lifetime might be needed, depending upon the amounts involved, instead of, or in addition to, a will trust.

Spouses and Civil Partners

In technical language, the types of discretionary trust we have just been discussing are “relevant property trusts”. The good thing about them is that they aren’t human beings and therefore they can’t die, so once money is in one it can never suffer that 40% “tax whammy” which this series of blogs is all about. The bad things about them are:

i. giving money to one in your lifetime leads to an immediate upfront inheritance tax charge at 20%: to use the technical terminology, it is a “lifetime chargeable transfer”, not a “potentially exempt transfer” like other gifts are;

ii. it is not a spouse or a charity, so it’s a taxable beneficiary of your will, and in the absence of other reliefs any money left to it will be taxed at 40%; and

iii. it suffers “ten-year charges” and “exit charges” at rates up to 6% - these will be the subject of a future blog.

An alternative type of trust is called an “immediate post-death interest” - usually abbreviated to “IPDI”. This happens where some person is entitled to income, from the date of the death. The good things about them are, firstly, that where the beneficiary entitled to the income is a spouse or civil partner, the gift to the IPDI is spouse exempt, and secondly, that there are no ten-year and exit charges. The bad thing about them is that they are taxed in tandem with that beneficiary’s inheritance tax affairs: which means they are added into the beneficiary’s tax estate – and therefore taxed at up to 40% – on the beneficiary’s death.

So, armed with all that background information, we can conclude:

1.           a.           that leaving anything non-taxable to a relevant property trust on the first death is a good thing, because the “bad” consequences of doing so are fairly limited, and the good consequence is that the money is protected from forming part of the second-death estate, and therefore avoids the 40% tax; and

              b.           that leaving anything that will be taxable to a relevant property trust on the first death is a bad thing because we suffer 40% tax on it straight away, unnecessarily; and

2.           a.           putting non-taxables onto an IPDI would be a bad thing, because we are wasting the spouse exemption, and aggregating those assets with the second death estate where they will [probably] eventually suffer 40% tax; and

              b.           putting taxables onto an IPDI is a good thing because we can use the spouse exemption to avoid tax on the first death.

So, in a big-money estate, that’s the best way to structure the will on the first death. Two flexible trusts in favour of the family as a whole, the first a relevant property trust for non-taxable assets, the second an IPDI for taxable assets.

And in a really complicated estate, one where you honestly don’t know whether there will be BPR or APR assets, or what their values might be, or whether all of them will get 100% relief or only 50% relief, you do something which on the face of it looks simpler, namely to have just one trust in the will, a fully discretionary one which takes everything. Then, when the first death actually comes and you have a perfect picture of the assets and their tax relief, the trustees of that trust “appoint out” an IPDI – something they are allowed to do within two years of the death – of the taxables, leaving a relevant property trust of the non-taxables.

Naturally, it doesn’t end there. You could still have a potential second-death IHT liability on the assets of the IPDI and on any assets owned by the survivor in his or her own name. That is where all the other strategies mentioned in my blog come in. In particular, the trustees of the IPDI need to think, on a regular basis, about whether they can afford to use the “large gifts” strategy in favour of lower generations of the family, without depriving the surviving spouse of assets he or she might need.

Inheritance Tax Strategy 7 - Use Your “Agricultural Property Relief”

Agricultural Property Relief is usually abbreviated to “APR”.

Agricultural assets are often free of inheritance tax.  The rules are quite complicated, but very broadly:

A. Farmers get 100% APR on farmland and buildings which they farm themselves, if they’ve owned the land for 2 years. (100% relief means no tax to pay at all.)

B. Agricultural landowners usually get 50% APR on land which is tenanted by someone else, if they’ve owned the land for 7 years.

Remember that if you’re a farmer you’re also in business, so Business Property Relief is relevant to you, as well.

There are lots of things I could say about Agricultural Property Relief, but these are the highlights:

1. You only get APR on the “agricultural value” of your land. Agricultural value is what the property would be worth if it were only ever used for farming. For example, imagine you’ve got a farm which would be worth £1million to another farmer, but you’ve actually obtained planning permission to build some houses on it, and you intend to sell it for £2million to a developer for that purpose. The value is £2million, but you only get APR on £1million, and the other £1million is taxable.

2. Just like BPR (see Strategy 6), it is easy to “waste” (rather than “use”) your APR. So, my advice is the same as in the previous strategy, and here it is again in bold type:

DON’T WASTE YOUR “APR” WHEN YOU DIE!!!

             As before, you “use” APR either by passing assets directly to a lower generation or by putting them on a first death discretionary trust, and you “waste” APR by leaving assets outright to a surviving spouse or civil partner.

 

Statutory Residency Test

Taxpayers and the Revenue have often argued, over the years, about whether someone really is "resident" in the UK for tax purposes or not. The government recently brought in a statutory rule in the hope of bringing some certainty to the question. Unfortunately, the new Statutory Residency Test is a daunting piece of legislation, and the test itself not always easy to apply. So I was delighted to come across a flowchart, which sets out the rules clearly in a graphical form.

Some background information can be seen here:

http://www.cbw.co.uk/statutory-residency-test-flowchart/

And the chart itself is here:

http://www.cbw.co.uk/wp-content/uploads/2013/05/Residency-test-flowchart-Mar13.pdf

UPDATE (December 2017): The content above has moved, but the flowchart can be found at this link:

http://www.cbw.co.uk/wp-content/uploads/2017/01/Residency-Test-Flowchart-new-Jan16-1.pdf

First Death Discretionary Trusts

I have had to explain this concept in writing more often, and over more years, than I care to remember! But I recently nailed it for a couple of lovely clients in a new way, that I hope makes it easier to follow (bearing in mind that it's not easy material!). Their business, life cover, pensions and death-in-service benefits were worth £2.38m:

For the purposes of the discussion below, I divide your estate into two types of assets, namely:

1. Assets which would be non-taxable in the estate of the first of you to die. This includes the first £325,000 of any estate (known as the “nil-band”), assets which qualify for business property relief or agricultural property relief, assets in pension schemes, or life policies written ‘in trust’. (This is wider than the strict legal definition of your ‘estate’.)

2. Assets which would be taxable in the estate of the first of you to die: i.e. everything else (especially, the house).

First Death Discretionary Trusts

The point of first-death discretionary trusts is to capture all non-taxable assets on the first death, and to cocoon those assets so that they never “belong” to the survivor of you and accordingly are not taxed on that second death, either.

Taxable assets, on the other hand, are left to the survivor of you, claiming the “spouse exemption” and therefore at least avoid being taxed on the first death (although any such assets unspent by the time of the second death will be taxed in the normal way).

In an estate where non-taxable assets are potentially a large proportion, first-death discretionary trusts can ultimately save a huge amount: 40% of the value of the non-taxable assets amounts to (40%x2,380,000=) £952,000.

The non-tax advantage of a discretionary trust is that although the assets do not “belong” to the survivor of you, those assets ARE available for the survivor to draw on, if needed.

Your Wills

The best way to establish a first death discretionary trust is in your will itself. This is the only way to capture the business: but other types of first death discretionary trusts are suggested below in relation to other assets.

Life Cover

It is generally unwise for people with estates over the tax threshold to hold life cover unless it is ‘in trust’. This is because assets payable directly to you are taxed as part of your tax estate, whereas assets held in trust are not. So you should get your financial adviser to get all the policies ‘written in trust’.  

In addition to this “first death” saving: there is also tax to be saved by either ‘appointing’ from these trusts so that the proceeds pass to the discretionary trust in your will; or (which may be neater, if your financial adviser can arrange it) getting them written onto discretionary trusts in the first place.

I am always happy to work with financial advisers on this.

Pensions

There is an automatic first-death inheritance tax saving attached to lump-sum pension payments on death and most death-in-service benefits. However to save second death tax one of the following should be done:

a. your pensions ‘nominated’ to the discretionary trust in your wills; or

b. your pensions settled on so-called “spousal bypass trusts” (which is just a term used in the IFA industry for a first death discretionary trust of pension benefits).

Again, your financial adviser can organise, and I’m happy to assist/facilitate.

Rysaffe Planning

Although first death discretionary trusts are designed to avoid the 40% “inheritance tax whammy”, they do suffer inheritance tax of their own, at rates of up to 6% on their value in excess of the nil-band, every ten years (or part thereof). There is a way of avoiding this tax, also, which is – instead of having one big discretionary trust in your will, or just a small number of them – to create a string of discretionary trusts on different days. These are funded with just £10 each, but at your later death each takes funding of about £300,000 – either from your will or from a life policy or pension scheme. The advantage is that each trust is worth less than the nil-band at the outset, so its ten-year charges should be nil, or very small.