How granny’s diamond ring could land you with an inheritance tax shock

The tax tops polls as the most hated in Britain. So it’s no wonder that families want to keep their estate tax (IHT) bills to an absolute minimum.

But research shows that last year more than 4,000 next of kin were investigated by HM Revenue & Customs on suspicions of underpaid estate tax.

The taxpayer handed out a £326 million bill for IHT payment errors in 2021/22 – a 28 per cent increase on the previous tax year.

The figures, contained in responses to a freedom of information request from insurer NFU Mutual, show HMRC is toughening up on families who either misunderstand complex IHT rules – or try to avoid paying.

So could you find yourself at the center of an estate tax investigation? And how do you avoid getting caught up in the maze of rules?

Taxman gets tough on missing dues

In the last tax year, an estimated 684 additional families were examined compared to the previous one.

Even some of the most diligent, with carefully crafted succession plans, were forced to cough up after being questioned.

HMRC says it will dedicate a larger number of officials to investigating estate tax payments this year.

Errors become more common as a greater number of assets exceed the tax-free thresholds for passing on wealth.

The first £325,000 of a person’s estate can be left tax-free. Above this level, all assets are taxed at 40 percent. The £325,000 zero rate threshold has been frozen since 2009 and will not rise for the next five years.

There is an additional allowance of £175,000 where the family home is bequeathed to ‘direct descendants’ such as children or grandchildren.

Spouses or registered partners generally do not have to pay tax on transferred assets.

Tracking down hidden riches

HMRC will review all sources of information about your family finances that it can get its hands on.

Everything from fine art to diamond rings – often forgotten or excluded from an estate – often leaves a paper trail. One of the most important is on your insurance papers.

HMRC has access to vast amounts of personal information through a database called Connect, according to Robert Levy, a tax research specialist at law firm Kuits Solicitors.

“They usually have all your property records, bank accounts, and insurance policies so they can get a pretty clear picture of your finances,” he says.

If IHT payments your family has made do not match HMRC’s own projections of what is owed, it will start asking questions.

An investigation can take months and even years as officials search for classified assets. There is no limit to the time the tax authorities have to investigate.

However, you will usually be notified within three months of payment from IHT if you are under investigation. “If they want to commit, they usually do it quickly,” says Levy.

“You would receive a letter with a list of questions for proof of valuations or questions about an asset you did not disclose.”

In many cases, there may be a legitimate reason for the shortfall. For example, the deceased spent the money HMRC believes he had, or his investments lost value and HMRC had no up-to-date accounts. Or certain things are simply forgotten when adding up an estate.

‘Sometimes there’s a painting on the wall that no one has thought of yet.

‘If it’s worth a lot of money, chances are it’s insured, so it’ll be on HMRC’s radar. They’re coming after it,” says Robert Levy.

Keep a record if you ‘donate’ it

One of the biggest points of contention between HMRC and families is gifts. You can gift assets to friends or family to potentially lower IHT bills: from furniture and jewelry to antiques and cash.

However, the gift is only tax-free if it was handed over more than seven years before the death.

Keep track of what you give, to whom, when it was given and what its value is. Otherwise, it is up to your family to prove that the donation was made more than seven years ago.

Mr Levy says: ‘Jewelry is often easy to ‘accidentally forget’ in the hope that it will go unnoticed. But often every item is insured, so HMRC has records of it. It’s hard to say it was a gift if it’s on the deceased’s insurance policy.’

The lawyer says that in one case a wealthy family did not list jewelry on the inheritance tax form.

A £10,000 diamond ring was one of the items on the late mother’s final insurance documents, and there was nothing to show it had changed hands. The family had to pay £4,000 in tax on the ring.

Mr. Levy says, “Items should not disappear. There’s a good chance HMRC will question it, and if they find out you haven’t revealed it, everything is up for grabs.

“From that point on, they’ll question everything because you’ve lost your credibility.”

Fines for non-payment

Last week, the interest on unpaid inheritance tax rose to 6 percent. It is the eighth time it has risen from 2.75 percent a year ago.

Depending on the reason for underpayment, a fine may then be added to the interest charge. If a mistake was made or insufficient care was provided, families could pay up to 30 percent of the extra tax due.

Intentional underpayment yields between 20 and 70 percent, while intentional action combined with concealment can amount to 100 percent of the additional tax due.

For example, if a £10,000 item – which was wrongly omitted from the bill and should have been taxed at 40 per cent – is discovered 12 months later and the family is fined 10 per cent, they owe £4,664.

This includes the £4,000 initial tax, plus a 10 per cent (£400) penalty and £264 interest.

It is therefore important to pay the correct amount the first time and then pay as soon as possible if you have paid too little.

Families paid a record £6.1bn in estate taxes last year, £729m more than the previous 12 months. Rising real estate prices are partly to blame for this.

Sean McCann, of NFU Mutual, warns that families could be investigated if they undervalue a home.

‘All HMRC has to do is go to an online site such as Rightmove and see how much similar properties have sold for,’ he says.

j.beard@dailymail.co.uk