Taxation of estates in administration

Aug 01, 2018
Executors must consider a range of issues if they are to fully discharge their relevant tax obligations.

An executor has many responsibilities, one of which is to deal with the tax affairs of the deceased. In addition to quantifying any inheritance tax liability and ensuring that all income tax and capital gains tax liabilities up to the date of death are settled, executors are also responsible for taxation during the period of administration, which lasts from the day after death until the estate is settled.

Income tax

During the administration period, executors are subject to income tax at a rate of 7.5% on dividend income and 20% on any other income. Unlike individuals, executors do not benefit from the personal allowance, personal savings allowance or the dividend allowance. Furthermore, there is no liability to higher rate tax.

Prior to 6 April 2016, executors were liable for income tax on dividend income at a rate of 10% and this was covered by the dividend notional tax credit. The abolition of the dividend tax credit, coupled with banks’ decision to cease the deduction of tax at source on interest income, has resulted in increased tax reporting requirements and additional income tax liabilities for executors in the administration period post-6 April 2016.

While the income arising in the period of administration is taxed on executors in the first instance, the residuary beneficiaries are ultimately personally liable for income tax on their share of the estate’s income.

For simple estates that are administered within one year, executors should provide the beneficiary with details of the estate income taxable on them via Form R185 Estate Income. In calculating the taxable amounts, general estate management expenses (for example, the costs associated with the preparation of tax returns) can be deducted. The beneficiary will use the R185 figures to complete his or her own tax return, as appropriate. The beneficiary then receives credit for the tax already paid by the executor. If they are basic rate taxpayers, there will be no further income tax to pay. If they are higher rate taxpayers, on the other hand, they will be subject to an additional inheritance tax (IT) liability. Alternatively, they may be due a tax refund if they are not a taxpayer.

Where dividends were received by the executor prior to 6 April 2016 but only taxed on the beneficiaries after 6 April 2016, such income must be separately identified to ensure that the tax credit is not treated as repayable to the beneficiary.

For more lengthy administrations, which may extend over a number of tax years, a record of the estate income arising and tax paid by the executor in each year must be maintained. The income will be taxed on the beneficiary when sums are paid to them (this includes a transfer of assets). If no distributions are made until the end of the administration period, the beneficiary’s share of the total estate income will be taxed in the final tax year of administration.

Executors should therefore consider, and discuss with beneficiaries, whether it is appropriate to make interim payments as the administration progresses to avoid, for example, needlessly pushing the beneficiary into a higher tax band or increasing income to a point that triggers a child benefit clawback.

Capital Gains Tax

Death represents a capital gains tax-free uplift to probate value for executors, who are treated as acquiring the assets at the date of death. During the administration period, executors pay capital gains tax at a rate of 20% or 28% on UK residential property. For the tax year of death and the two subsequent tax years only, the executors have a full capital gains tax annual exemption, which currently stands at £11,700. 

In calculating the gain, executors may make a deduction to represent the costs of establishing title. This is a scale rate dependent upon the value of the deceased’s estate.

If assets are to be sold during the administration period, consideration should be given to whether the sale ought to be carried out by the executors or by the beneficiaries. It may minimise capital gains tax to transfer assets to the beneficiaries prior to a sale as the beneficiaries may have a larger available capital gains tax annual exemption; they may pay capital gains tax at the lower rates of 10% or 18%; or they may have personal capital losses to use.

If certain estate assets (including land and quoted shares) realise a loss on sale within prescribed time periods, the executors may claim inheritance tax loss on sale relief. This effectively substitutes the sale proceeds for the probate value for inheritance tax purposes, resulting in an inheritance tax refund. If no inheritance tax was paid, inheritance tax loss on sale relief is not applicable. Therefore, for assets standing at a loss, consideration should be given as to how best to utilise the loss. For example, should the asset be transferred to the beneficiary to sell, or can the executors sell other assets at a gain to fully utilise their capital losses before the end of the administration period?

As always, appropriate tax advice should be taken to ensure that the executors are meeting all relevant tax obligations.

Fiona Hall is Tax Principal at BDO Northern Ireland.