Death and taxes

Allow me to put this proposition to you: a great many solicitors are getting it wrong when it comes to income tax issues in the course of an executry. Okay, so you will all be aware of the IHT issues that are relevant, but to be honest, IHT will not be relevant in every case, whereas income tax will almost certainly be. I’ve been working in tax for many years, having started my career working on the accountancy side, and now deal with tax issues as they affect individuals, executries and trusts.

When I was on the “other side” I, and my colleagues, always had a sneaking suspicion that the information we were getting from solicitors when one of our clients had inherited from an estate was not always correct but, on the assumption that the solicitors knew what they were doing, I had no option, and no reason, other than to accept either the figures given on any R185 tax certificates that had been prepared or, indeed, that no R185 was required as no income had arisen during the executry. With the benefit of having worked on the legal side, I now know that this was probably incorrect in many cases.

Not so simple

An estate would have to be extremely simple for there not to be any income arising. I accept that, years ago, many clients did have relatively straightforward estates, but in recent years it has become commonplace for even a modest one to contain a few bank accounts, a PEP or ISA investment, a private investment portfolio, all of which are likely to give rise to income. Where the investments are significant, matters become yet more complex.

HMRC guidance (at TSEM7356) explains what personal representatives/executors do as regards deceased persons, and specifically states that any income received by them has a liability to income tax at either basic rate or the rate applicable to dividends. There may also be a liability to capital gains tax if they dispose of assets during the period of administration, although there is more than enough to be going on with on the income tax side of things in this article! It follows, therefore, that if executors receive any income that is untaxed, they have to account for tax on it.

Typically, untaxed income might consist of bank interest or Treasury stocks paid gross, National Savings investments or rental income. A tax liability of 20% arises here (executors are not liable at higher rates), and the executors – or solicitors acting for them – are responsible for paying this over to HMRC.

If it is not a complex estate, HMRC will deal with matters under the informal procedures so, in any case where tax is due, this can be dealt with at the end of the administration period. You would simply send off a letter and cheque to the deceased’s tax office, advising that income of £x arose in the executry, on which tax of £y is payable.

If it is a complex estate, it is likely that HMRC will issue tax returns for completion for each year the administration is ongoing, and in such cases any tax will be due by 31 January following the end of the tax year.

How do HMRC know whether it is a complex estate or not? Well, if matters have been dealt with properly, a form R27 “Potential repayment to the estate” will have been completed and submitted at the commencement of administration, and the information on this form allows HMRC to decide whether tax returns will be necessary.

There are a couple of reasons why it is extremely important that this form is submitted:

• It will finalise the deceased’s tax affairs to date of death. An executor has a duty to ensure that the deceased’s tax affairs are in order. There is nothing worse than finalising an executry and paying everything away to the beneficiaries, only for HMRC to raise queries many months later when they eventually find out the taxpayer has died. Do you admit to the clients that you haven’t dealt with matters properly, and tell them you’re going to have to charge them for dealing with this now? Or do you just do what needs done and write off the time?
• It will provide a figure to include in the inventory, either an asset at date of death (when there is a repayment due to the deceased) or a liability of the estate (when tax is due by the deceased), and it is crucial that one or other is taken into account because it could mean under- or over-stating the value of the estate at date of death, and possibly under- or over-paying IHT.

Assessable income

But I digress slightly. Although there are equally numerous issues that an executor has to consider in relation to tax matters in the period to date of death, we are considering tax during the administration period for now.

It might not always be easy to identify the income that has been received by the executors, and this is particularly true where there are numerous investments held with a portfolio manager. Imagine a typical entry on an inventory showing an investment portfolio with AT Ltd, which consists of several underlying holdings with a total value of £75,000 on 2 April 2009 when the client died. On 19 December that year, following instruction to sell, the solicitors received the sum of £78,000 which, on the face of it, gives a gain of £3,000. Observations?

I’m sure you won’t be surprised to know that this is probably not correct. It might seem that putting a total figure for these in the inventory would simplify matters, and then the difference between date of death value and eventual sale proceeds would be a gain, but that will not be the case unless none of the investments produced income. And by that, I don’t just mean actual cash: distributions on reinvested or accumulation shares don’t give rise to any actual “cash” receipt but are, nevertheless, still assessable for income tax purposes.

So, the date of death figure of £75,000 is made up of holdings in several companies, and whilst it is not absolutely necessary to show each on the inventory, it is preferable to do so. However, even if you don’t list them separately, you still have to analyse each one separately when you prepare a final account for the executors, so that you can properly reconcile the funds and identify any income received. A proper reconciliation is required for every asset, even if just a bank account. Without wishing to state the obvious, there should never be a gain on a bank account, and if the balance at realisation is higher than at date of death, you should ensure that you know why this is, and whether any of it includes income.

Certificates in time

It is not appropriate to wait until the executry is in its final stages to consider what tax certificates might be required. Good practice dictates that ongoing executries are reviewed after 5 April each year to check whether R185s are necessary, but this is another area where mistakes can be made. Basically, a certificate is required if a payment has been made to a residuary beneficiary and there has been income arising in the tax year in which that payment is made. If no payments have been made in a particular tax year then, even if there has been income arising in that year, a tax certificate will not be required. The income will be carried forward until either a payment is made or the administration is completed and all the income is paid out. However, very often assets are transferred shortly after date of death, but the taxation consequences are ignored.

The definition of “payment” includes the transfer of assets in satisfaction of a share of residue. Typically, this could be things like a half share of a joint bank account, household contents and personal possessions, shares or other property, so a transfer of any of these to the residuary beneficiaries will be treated as a payment. Often, things like jewellery and other personal possessions are transferred very quickly following the death so, if a payment has been made, and there has been income arising in the tax year (which may well have arisen after the date the items were transferred), the beneficiary is treated as having received the lower of (a) the amount paid over, or (b) his share of the assessable income for that year. See the panel on p19 for an example.

Finally, once an R185 certificate has been prepared, it should be sent out to the beneficiaries explaining that they may require it for either their own tax returns or to claim a repayment of tax. Beneficiaries who receive a self assessment tax return are obliged to submit their return by 31 January following the end of the tax year, so will not be pleased to have to wait until January to get the certificate from the solicitors dealing with the estate. They may well already have submitted their return by then, so would have to submit an amended return, possibly incurring more fees to their professional adviser for the costs of doing so. Additionally, if they are higher rate taxpayers or fall into the higher rate because of the income received from the executry, this could result in them having to pay more tax. It goes without saying that a beneficiary would be even less happy to get the certificate after 31 January!

HMRC raise the stakes

Tax is rarely an interesting topic, but it cannot be denied that it is an ever increasing element of the work involved in dealing with an executry. It might seem much easier to draw up a straightforward account of charge and discharge rather than to properly address the tax issues: after all, many people involved in the case – whether executors, beneficiaries or indeed, the solicitors – are of the opinion that if the account balances then everything must be all right. But really, do you want it to balance, or do you want it to be correct?

It is well known that HMRC for their part, now seem to be of the opinion that a great number of tax advisers (which would include a solicitor dealing with an executry) are deliberately negligent and want to bring in legislation to combat this perceived and supposedly rampant wrongdoing. Add to that the fact that society, whether in the guise of executor or beneficiary, has become extremely litigious, and the profession is facing an onslaught from all directions. It is in everyone’s interest to fully consider and investigate the income tax issues that might arise during the course of administration.

• Lesley Rance is a tax adviser with Miller Hendry, solicitors, Perth

When “payment” gives rise to tax

As to the layout of the executry account, it is sometimes not immediately obvious when an asset is paid over, which is why it is more helpful from a tax point of view to actually state the date of transfer in the account. To illustrate why the date is relevant: a taxpayer dies 1 January 2007 with an estate consisting of his half share in the matrimonial home and contents, a car, a joint bank account and a substantial investment portfolio. His widow is the sole residuary beneficiary. She “took over” the joint bank account, the half share of house and contents and the car immediately after the date of death, but the family took many months to decide what to do with the shares. Eventually they were all sold, and the funds were paid over to the widow on 30 April 2009. Up to that point, the portfolio had generated income of £1,000 in 2006-07, £2,000 in 2007-08 and £1,200 in 2008-09. Nothing of this was paid over to the spouse until 30 April 2009.

On the face of it – and in the old days pre-Finance Act 1995 – this income would all be assessable on her in 2009-10, the tax year in which the funds were paid over. However, this is not now correct. For the purposes of income tax, income is deemed paid where there is a transfer of assets during the administration period so, because she received a “payment” in 2006-07, the £1,000 of income from the portfolio is deemed as her income, even although she did not actually receive it until much later, and an R185 tax certificate should have been prepared for the year. Nothing was paid over to her in the 2007-08 or 2008-09 tax years, and the investment income in these years is rolled forward to 2009-10, the year in which the final sum is paid to her. The second R185 tax certificate will therefore include the income arising in three tax years.