The heart and sole of a law firm: Inheritance tax law firm owners

Building a law firm from the ground up is hard with a quarter of new businesses in the legal industry failing to make it past the first five years.

If you are the sole owner of a law firm, you don’t want the business you worked so hard to build subject to a huge Inheritance Tax bill, which is why it is important to plan for this well in advance.

What is Inheritance tax?

Inheritance Tax (IHT) is paid at 40 per cent on the money, property and possessions of somebody that has passed away. As you will know, It is calculated by totalling all the assets of the deceased person’s estate.

There are certain thresholds on IHT, you have a £325,000 standard allowance before you have to pay the 40 per cent charge.

If you pass the primary home on to your children or grandchildren your tax-free allowance can be increased by an extra £175,000 totalling £500,000.

Beyond this there are various reliefs to rely on, but at some point, if your estate exceeds these thresholds a 40 per cent charge is imposed on the amount that exceeds this.

How does Inheritance Tax affect sole owner law firms?

As the sole owner of a UK law firm, the business will typically qualify for Business Property Relief (BPR) which has historically protected businesses from large IHT bills.

However recent changes have capped the 100 per cent BPR allowance at £2.5 million per individual, any business over this amount will now receive a 50 per cent relief making it subject to an effective IHT rate of 20 per cent.

Sole owners of law firms will typically qualify for BPR providing you have owned the firm for over two years prior to death.

Any unused allowances can be transferred to a spouse or civil partner which effectively doubles the 100 per cent relief threshold to £5.65 million for married couples.

It is important to note that the law firm must be ‘wholly or mainly trading’ if the firm generates significant income from passive funds the business may be disqualified or partially disqualified from relief.

What are the potential risks of inheritance tax on sole owner law firms?

Qualifying for BPR removes much of the stress of being held accountable for IHT, however there may be some risks that owners face, for example:

• Client money – Any money that is held in client accounts is strictly not considered an asset of the business. This does not count towards the value of the business for tax valuation.
• Work in progress and debtors – Any work that is unbilled or has outstanding invoices will be included in the valuation of the law firm. This includes physical office assets like computers or law libraries.
• Valuation differences – Your firm will be valued at the rate that HMRC decides it could be sold for on the open market at the time of death.

It is always important to get in contact with an accountant for advice on how to organise your business before death.

How we can help you mitigate against inheritance Tax

You may have worked for years to build your law firm from the ground up and wish to pass it on to inheritors, with careful planning it is possible to lessen your tax bill to make sure your inheritors can carry on your business without worrying about finances.

Our team here at Moore Thompson are only a call away, we can help you manage your tax bill in the event of your death.

Get in touch today, for expert advice on managing your tax.