Why small business owners shouldn’t ignore IHT

Leaving your family business to the next generation could soon become much more costly and complex. Changes to inheritance tax relief will have a bigger impact than many small business owners expect. Here’s what you need to consider.

When Rachel Reeves announced changes to the rules on inheritance tax (IHT) relief last October, it provoked a big reaction. Thousands of farmers (including Jeremy Clarkson) marched on London to protest about a reduction in agricultural relief.

There was less of an outcry, at least in the headlines, about how similar changes to business relief could affect business owners and their legacy plans, even though we believe this has the potential to have just as significant an impact.

If you own a small or medium-sized business, we believe IHT might need to be a much more important part of your conversations around tax planning for the future.

What are the rules on business relief and what’s changing?

Under the current rules, there’s no IHT charge for someone inheriting a trading business (or interest in a business) or shares in an unlisted trading company. Subject to meeting certain qualifying criteria, such as a minimum 2-year ownership period, they would qualify for 100% business relief.

Next April, this relief will be reduced. From then 100% relief only applies to the first £1 million. Above that, the relief is cut in half. This means paying an effective rate of 20%. It’s still a lower rate of inheritance tax than the standard rate of 40%, but for family businesses that up to this point hadn’t factored in a charge, it could have a serious impact on their succession planning.

Any business worth more than £1 million could be hit quite significantly by this move. What’s more, with company valuation often a complex affair, many businesses could fall into this category without realising it. Family Business UK analysed the impact of changes to Business Property Relief and warned that if the cap doesn’t move with inflation, then many more could be affected in the future.  What’s more, CEO Neil Davy says the changes “fundamentally remove incentives among owners of family firms to invest in their businesses, and in many cases threaten their viability.”

What to do next

The reduction in business relief puts more emphasis on the options for gifting value during your lifetime, but there are rules around this. It’s possible, for example to make use of the annual gifting allowance of £3,000, but anything over this amount may be treated as a ‘potentially exempt transfer’ and liable for IHT if you die within seven years of making the gift.

If you’re thinking about passing on shares in your trading business, whether directly to family or into a Trust for their benefit, there is a window of opportunity now to undertake some valuable planning ahead of the new rules coming into force. The government has introduced “anti-forestalling rules” which apply to lifetime transfers taking place between the Autumn Budget in October 2024 and 5 April 2026, which should not be overlooked. Transfers from 6 April 2026 onwards will fall within the new rules and may limit lifetime planning opportunities. One measure of mitigation to consider is that there’s more flexibility in how those inheriting pay the IHT charge. From April 2026, IHT on business properties can be paid interest-free over 10 annual instalments.

Don’t delay, act now

Our message to all business owners is simple. You can’t afford to bury your head in the sand.

Whatever the size of your operation, being proactive about succession and estate planning is the best strategy.

At AAB, as a one-stop-shop for business and financial advisory services, we have the benefit of bringing in experts from many fields, including tax specialists, wealth management experts and business advisers. This provides you with a much more joined-up approach.

For advice on the right way forward for your business, speak to our financial advisors or tax experts today.