As we all know, there are two certainties in life - death and taxes.

Here, Paula Patton, private client solicitor at our Birchington office, explains how there is a third certainty because the law favours married couples and those in civil partnerships to cohabiting couples regardless of the length of the relationship and whether or not they have children.

Inheritance Tax (IHT)

As house prices rise, more and more estates attract inheritance tax (IHT). The general rule is that IHT is payable at 40% on the balance by which a person’s assets upon death exceed the IHT nil rate band (currently £325,000). However, the spouse exemption, which was introduced back in 1974, allows married couples (and this has now been extended to civil partners) to leave their whole estate to their spouse or civil partner tax free. Yes, that means that no IHT would be payable upon the death of the first civil partner or spouse.

In addition, if the nil rate band of £325,000, or part of it, is unused on the death of the first spouse/civil partner (most often because the majority or all of the estate of the first to die has been left to their spouse or civil partner), the remainder of the nil rate band can be transferred to the surviving spouse/civil partner. This usually results in a tax free estate of £650,000 upon the death of the second spouse/civil partner.

With cohabiting couples, however, even if they make provision for each other in their Wills, there is no spouse exemption and no possibility of transferring the nil rate band of the first to die to the survivor. This can mean that a surviving cohabitee will find themselves having to settle an inheritance tax bill. Further, after the death of both cohabitees, the estate will not benefit from the transfer of the nil rate band of the first to die so there is likely to be a second tax bill upon the death of the second cohabitee.

Example 1

A and B have been together for 25 years and have made the conscious decision not to marry/become civil partners. A owns their home in A’s sole name. A has no other significant assets. In A’s Will, A leaves the home to B. A dies and B inherits the home which has a value of £500,000 upon the death of A. A’s nil rate band of £325,000 can be claimed. Tax is, however, payable on the remaining £175,000 at 40% meaning that tax of £70,000 is payable. Had A and B been married/civil partners, no IHT would have been payable upon the death of A due to the application of the spouse exemption.

Provided B manages to retain the family home despite IHT being payable on A’s death, if at B’s death, it is worth £650,000, the estate will only be able to claim B’s nil rate band of £325,000 so tax will be payable upon the remaining £325,000 at 40%, so tax of £130,000 will be payable giving a combined tax bill for A and B’s estate of £200,000.

Had A and B been married/in a civil partnership, due to the possibility of transferring A’s nil rate band of £325,000 to B upon A’s death, the estate would have been able to claim both A’s transferable nil rate band of £325,000 and B’s nil rate band of £325,000. As the estate was worth £650,000 upon B’s death, no IHT would have been payable.

NB In both scenarios, the recently introduced residence nil rate band (RNRB) may be applicable. Further reference to this is made below.

Residence Nil Rate Band (RNRB)

In 2017, the RNRB was introduced which enables an additional tax free sum, currently up to £175,000, to be claimed where a property is left to lineal descendants such as children, stepchildren or grandchildren.

Where a couple are married/civil partners, in much the same way as the transferable IHT nil rate band referred to above, even if the first spouse/civil partner died before the introduction of the RNRB, their unused RNRB can be transferred to the survivor so that upon the death of the surviving spouse/civil partner, it should be possible to claim the £175,000 unused RNRB of the first to die plus the unused RNRB of the second to die, potentially giving an additional tax free sum of £350,000. This would be so provided the property in question has a value the same as or exceeding £350,000 and provided other conditions are met, such as the property passing to lineal descendants.

Potentially, the estate of a married couple or civil partners could be tax free up to £1 million.

However, with a cohabiting couple, it is not possible to transfer the unused RNRB of the first cohabitee to die to the survivor so in Example 1, A’s unused RNRB could not be transferred to B so will essentially be lost. Upon B’s death, if the home is left to A and B’s mutual children, B’s unused RNRB should be possible to claim but this means that only an extra possible £175,000 tax free could be claimed, not £350,000 as for a married couple/civil partners.

Example 2

Based on Example 1, upon B’s death, if the property is left to their mutual children, it should be possible to claim the RNRB of £175,000, so the taxable estate of B of £325,000, after deducting B’s nil rate band of £325,000 from the estate value of £650,000, can be further reduced by the RNRB of £175,000 to £150,000 so tax at 40% of £60,000 is payable. This does therefore reduced the combined tax total payable in relation to A and B’s estate to £130,000 but had they been married/ civil partners, no tax would have been payable at all. If A’s children were not B’s children however, by leaving the whole estate to B, and then to A’s children upon B’s death, the possibility of claiming the RNRB would be lost as A’s children would not be considered to be lineal descendants of B, as they are not stepchildren due to A and B never having married/formed a civil partnership.

The situation can be complicated further where a cohabiting couple have children from different relationships as if, for example, rather than leaving the home to B, A had given B the right to live there for life and for A’s own children to inherit the property after B’s death, as B is not a spouse/civil partner, even though A is providing for A’s own lineal descendants, the chain is essentially broken by giving a life interest to B and the possibility of claiming A’s RNRB will be lost.

The importance of making a Will

Where a spouse/civil partner dies without having made a Will, the intestacy rules make automatic provision for the surviving spouse/civil partner. Please note however that this automatic provision does not necessarily mean the surviving spouse/civil partner will receive the whole estate, so it is important to make Wills to ensure that your wishes are carried out.

Where a cohabitee dies without a Will, the intestacy rules make no provision whatsoever for a surviving cohabitee, regardless of their circumstances. It may be possible to rectify this by claiming financial provision under The Inheritance (Provision for Family and Dependents) Act 1975 but this may involve considerable legal costs and prolonged legal proceedings with no certainty of a successful outcome.

We appreciate that this is a complicated area of the law. There is no doubt, however, that the law treats cohabitees far less favourably than married couple/civil partners. When making your Will, we are happy to discuss the tax benefits and pitfalls with you.

Paula Patton can be contacted on 01843 842356 or by email at pdp@boysandmaughan.co.uk. If you already have a Will Paula would be pleased to review it for you.