Tax Liabilities of Deceased Estates
The death of an individual can understandably be a difficult time, however tax obligations, such as the requirement to file tax returns and pay the tax due on behalf of the deceased, do not cease upon death.
The tax liabilities can be split into two parts: the deceased’s tax affairs up to the date of death; and the period of administration (i.e. the period following death up until the date that estate is distributed).
Part 1: Tax affairs up to the date of death
On the death of an individual, it is the personal representatives’ responsibility to file a tax return disclosing all income received by the deceased taxpayer from 6 April up to the date of death.
Income tax will be charged as normal on all taxable income arising up to the date of death. Typical sources of income include pension income, employment income, bank interest, rental income, and dividends.
Some taxable gains can be triggered by the death of an individual (i.e. chargeable event gains) and these must also be declared on the return.
As normal, the deceased will be entitled to their entire personal allowance in this period (£11,000 for 2016/17), regardless of the length of time between 6 April and the date of death.
Capital Gains Tax
Capital gains tax will become chargeable on any gains made in the relevant period where the deceased sold an asset.
As with the personal allowance, there is no restriction imposed on the amount of the annual exemption deductible for the year in which the individual died. Therefore the full annual exemption (£11,100 for 2016/17) will be available.
From April 2016 the capital gains tax rates were reduced to 10% for gains received within the unused basic rate band, and 20% for gains exceeding it for most assets. However, it should be noted that the rate of capital gains tax remained at 18%/28% for the sale of residential property.
Any losses incurred on the sale of an asset can be carried back and offset against gains arising a) first in the tax year of death, and then b) in the three years prior to the tax year in which death occurs on a last-in-first-out basis. Any excess losses not relieved against capital gains will be lost.
Part 2: Period of administration
Tax returns may also be required to account for any income or gains made by the estate during the period of administration.
The period of administration, or administration period, is the time between the day after death and the date that the personal representatives ascertain the value of the estate and distribute the assets to the relevant beneficiaries.
Tax returns for the period of administration must be prepared and submitted if any of the following apply:
- The total income tax and capital gains tax due exceeds £10,000;
- The proceeds of assets sold exceed £500,000 in any one tax year (£250,000 for tax years before 2016/17); or
- The estate was worth more than £2.5m at the date of death
Where these limits are not breached it may be possible to settle any tax liabilities through a more informal route, by writing to HMRC setting out details of income and gains.
During the administration period, income tax will be chargeable on all income received by the estate. This often includes rental and investment income.
Unlike individuals, estates are not entitled to the personal allowance, therefore all income received will be taxable, however the rate of tax is limited to the basic rate of tax of 20%.
For the years up to and including 2015/16, dividends were taxed at the effective rate of 0%, however from 2016/17 onwards, dividends will be taxed at a rate of 7.5%. Estates are not entitled to the £5,000 dividend allowance.
Capital Gains Tax
On the sale of assets during the period of administration, capital gains tax will be charged at the rate of 20% (or 28% for residential property).
CGT will not be charged where assets are transferred to beneficiaries in accordance with the will/intestacy, or where the assets are appropriated to a beneficiary prior to sale (although the beneficiary will need to consider there own tax position).
The gain on which capital gains tax will be chargeable is calculated by deducting the probate value (i.e. the market value of the asset at the date of death), any enhancement expenditure, incidental costs of the sale, and costs of establishing title – typically these are calculated using the HMRC scale rates set out in SP2/04.
Care will be needed in relation to the probate value used as the base cost, and consideration should given as to whether the probate value was ascertained by HMRC during the probate/IHT process.
The annual exemption is only available for the tax year of death and subsequent 2 tax years.
Once the period of administration has ended, it is possible to write to HMRC to request clearance that HMRC do not intend to enquire into the returns submitted.
This provides reassurance to personal representative’s that the tax position has been brought to a conclusion, although it should be noted that such clearances can only be relied upon where the full facts have been disclosed to HMRC.
As demonstrated in the case of Graham Usher & Martin Perkins Executors of Terence Guy Deceased v HMRC, the personal representatives can become personally liable for tax liabilities where the assets have already been distributed to beneficiaries.
Part 3: Beneficiaries’ tax position
Where the estate produces income, this will be taxable income of the beneficiaries who will receive a tax credit for any tax paid by the personal representatives.
The timing of the beneficiaries tax liability will depend on when they receive distributions from the estate and whether they were bequeathed a specific legacy or an interest in the residue of the estate.
Personal representatives should provide the beneficiaries with a form R185. This is a statement showing the amounts treated as income and the amount of tax deemed to have been paid by the estate.
Where the beneficiary has little or no personal tax liability, they may be able to claim a repayment of the tax deducted in respect of income from the estate in which tax was deducted at source.
Where beneficiaries sell assets they received from the estate, they will be liable to capital gains tax in accordance with normal principles with the base cost being the probate value of the asset concerned.
Part 4: Disposal of Assets and Tax Planning
As noted above, as a general rule the personal representatives of the estate are liable for capital gains tax payable on disposals during the period of administration.
However, where steps have been taken to vest the asset in the beneficiaries’ names prior to the sale, the gain may instead accrue to the beneficiary.
This may be more tax efficient than the capital gains tax arising in the hands of the personal representatives as each beneficiary is entitled to their own annual exemptions. In addition, any gains falling into their unused basic rate bands will be taxable at the reduced rate of 10%.
Where personal representatives are liable for capital gains tax, losses made on the sale of an asset are lost when the period of administration ends. It is therefore preferable for the losses to accrue to the beneficiaries as they can be carried forward and relieved against any future capital gains.