You might say, having glanced at the title of this article, interesting but irrelevant for all but the very wealthy. That may or may not have been true in the past. However, in the wake of government bailouts of pivotal financial institutions, one point is frighteningly clear. Taxes, and in particular, inheritance taxes are going to dramatically increase. The increase will be in two forms: the actual percentage of tax will be increased and the value of the assets exempt from the tax will decrease. This will mean that inheritances that were previously free and clear of tax will no longer be. 

In the United States, for example, as of January 1, 2011, the asset amount exempt from tax will be cut by over 70%, from the 3.5 million dollars in effect in 2009 to one million dollars. The rate of tax will be increased to over half the value of the estate’s assets, to a punitive 55%. In addition, it will be necessary to file an estate tax return with the I.R.S. for all estates with assets of $50,000 or more thereby effectively requiring the heirs of virtually every estate to file.

In South Africa the basic rule of thumb is that estate tax is levied at 20% of the value of the estate over and above the sum of 3.5 million rands. At least for the time being, both the rate of the inheritance tax and the exempt amount are comparatively low.

In Canada, as in Israel, there is no inheritance or estate tax as such. However, in Canada, unlike Israel, inheritances are subject to the imposition of capital gains tax which can exceed 40% of an asset’s value. The tax is due and payable regardless of whether or not a given asset is sold by the heir inheriting it.

In the United Kingdom, at the time of writing this article, the nil rate band (or tax exempt amount) is already limited to 325,000 sterling with a 40% tax on the excess. The financial austerity measures still to be introduced will probably result in a worsening of this already dire situation. The Conservative Party’s platform pledge to raise the nil rate band was one of the first casualties of the negotiations leading to the LibCon coalition.

Clearly then, both the scope and percentage of the inheritance tax merits your careful attention. There are a variety of estate planning techniques that if properly selected and utilized can legally eliminate or at least sharply reduce the inheritance tax otherwise applicable.

Ignoring the tax issue (as all too many people are prone to do) is usually a recipe for financial disaster. In the United States, the United Kingdom, Canada and South Africa among others, the respective revenue authority of each country has made it virtually impossible to transfer the registered ownership of a decedent’s financial assets without first obtaining a clearance form issued by it. Issuance of the clearance is conditional upon the filing of a complete estate tax return (including the estate assets based outside the U.S.) and full payment of the estate tax.

Let’s examine a little known estate planning device that can have an enormous impact on the tax liability of an estate. When a U.S. citizen dies, as a rule, his or her estate passes tax free to the surviving spouse. This is by operation of what is known as the marital exemption. However, if the surviving spouse is not a U.S. citizen, then the marital exemption simply does not apply. In such a case, as from 2011, the inheritance tax of 55% will apply to the whole of the estate. This, however, is not an unavoidable result. On the contrary, the U.S. citizen spouse can, by forming a QDOT or Qualified Domestic Trust, neutralize the impact of the inheritance tax on the surviving non U.S. citizen spouse. 

Here is a second example of the need to be proactive with estate planning. In the United Kingdom, a domestic partner has virtually no rights of inheritance in the estate of his or her domestic partner. By domestic partnership, we are referring to a long term relationship between a man and woman living together as husband and wife but without a state-sanctioned marriage. Non inheritance is the rule irrespective of how long the couple may have lived together and irrespective of whatever asset-sharing arrangements they may have established. At the very least, there is an obvious need for a valid Last Will & Testament to endow the domestic partner with specified rights in the other domestic partner’s estate. In addition, depending upon the scope of the assets transferred, planning needs to be invoked to minimize the impact of inheritance tax.

On the other hand, here in Israel, the rights of a domestic partner or the “Yadua Betsibur” are well established by both law and judicial precedent. Indeed, it is possible to assert that the inheritance rights of a domestic partner in Israel equal and sometimes exceed those of a married partner. At the very least, the partners in a domestic relationship are well advised to ensure that each of them has a valid Last Will & Testament which meticulously lays out the identities and the respective shares in the estate particularly if they have children from a previous relationship. 

In the United Kingdom, various types of trusts have come to the aid of taxpayers for decades. The Inland Revenue Authority is aware of the use of trusts as a means of tax planning. Provided the rules and regulations have been followed, an estate plan will normally pass muster thereby, resulting in a significantly reduced tax bill for the heirs.

In conclusion, as unpleasant as it is to contemplate one’s own mortality, an even more unpleasant scenario is the possibility of a given tax authority rather than your chosen heirs receiving a major portion of your estate. As a practical matter, you should consult with a tax professional with proven expertise in this area sooner rather than later.     

This article is for informational purposes only and is not a substitute for specific legal advice based on individual consultation.

Attorney Kahn has practiced law in Israel and The United States for over 35 years. For further information, see listing in ESRA’s Classified Directory