I’m terminally ill – how can I sort out my affairs for my young child?

I have a terminal illness with a poor prognosis. I have a young child whose father (we never married) isn’t involved. When I pass away, the mortgage on our home will be paid off and the home will be held in trust until my child reaches 23.

I have two questions please:

1 Will my child have to pay inheritance tax at that time (under current rules) on the value of the home (>€335,000) or any finances that might be there at the time?

2 I would have been due to inherit half of my parents’ home in future if it weren’t for my illness. They will now outlive me by decades (hopefully). Instead, my child will inherit my half when the time comes. Will there be more inheritance tax to be paid given the grandparent/grandchild relationship versus parent/child? Or would we meet any special circumstance to merit falling in to Category A.

Finally, I’d appreciate if you had any advice on what I could do now to minimise tax to be paid in either of the circumstances above.

Ms N.O’M., email

The situation you find yourself in is desperately sad, especially as you are sole parent to what is a very young child.

You clearly have had the time to think this over and have made certain arrangements. Most notably, this appears to include the creation of a discretionary trust to provide for your child.

Trusts are a useful way to provide for the welfare of dependents, including young children, especially in situations when we might not be there ourselves to manage their financial affairs.

A discretionary trust gives the trustees more discretion to hold on to the assets until they are comfortable that a young person is sufficiently mature to manage them – or, as seems to be the case here, an age older than 18 at which the person setting up the trust feels they should have access.

The downside is that discretionary trusts are also seen by tax authorities as structures that can be used for tax avoidance. As such, they can attract additional taxation.

As far as inheritance tax goes, this is applied at the point where your child gets control of the assets – in this case at 23. But what will be taxed?

Clearly it will include any assets still in the trust, but also any spending from the trust on their account for their care, support, education, maintenance, etc unless it is covered by an exemption. In that regard, section 82 (4) of the Capital Acquisitions Tax Consolidated Act 2003 (CATCA), as amended by section 81 of the 2014 Finance Act, allows that, for a child, including an orphan, such spending is exempt where it would normally be part of a parent’s spending on the child.

The 2014 amendment extended this exemption from 18 to 25, where the child was still in full-time education.

There are few among us who really believe that an 18-year-old is sufficiently mature to be asked to take full responsibility for their lifetime finances

So, your child would not be liable to inheritance tax for any money spent on their care and education up to the age of 23, when you have decided they should get control of their finances.

The wording of CATCA 82 (4) states “at a time when the disponer [you] and the other parent of that minor child are dead” but as a similar exemption is extended to children whose parents are alive, I cannot see how it makes a difference that your child’s father is alive, albeit not involved.

Discretionary trust tax

It is worth noting that the fund will be liable to a discretionary tax levy of 6 per cent of the value of the assets when your child turns 21. This is something that was put in to address Revenue concerns that some people were using the discretionary trusts structure for tax avoidance.

In the year following that initial charge, a 1 per cent tax will be levied on the assets in the fund on December 31st. The same will happen for each subsequent year until the trust arrangement is ended. In your child’s case, this means their trust will face the 6 per cent once-off charge and one annual 1 per cent charge before they get control – at which point they will have an inheritance tax bill on anything above€335,000 (or whatever the category A exemption threshold is at that date).

The alternative is a bare trust. In tax terms, this can sometimes make more sense – depending on the circumstances and investment performance of any assets – because the tax is paid at the outset and and not later when the child gains control of the assets.

The downside is that, under a bare trust, the child can demand control of the whole estate once they turn 18, an age at which they may not yet be mature enough to handle the responsibility. There are few among us who really believe that an 18-year-old is sufficiently mature to be asked to take full responsibility for their lifetime finances.

And, in your particular circumstances, it would likely lead to an increased tax bill for your child, so it has little to recommend it here.

Dwelling home exemption

You ask whether the child will have to pay inheritance tax on the family home? There is an important exemption to inheritance tax on a property where the person receiving it has lived there for three years up to inheriting it, is left the property by the owner and has no interest in any other property.

This is called dwelling house relief and, thus far, would certainly apply to your child. However, the rules also state that the person must continue to live in the property for the next six years. This might appear to rule out your child.

But I checked with Revenue, and they said the occupation requirements – both the three years and the six years – “are determined by reference to the date of the inheritance”. And they further note that the date of the inheritance “is the date on which the beneficiary becomes beneficially entitled in possession to the dwelling house”.

For most people this is when the owner dies. However, under a discretionary trust (but not, I believe, a bare trust), the date of inheritance is when the person takes control of their affairs. In your child’s case, this is at 23, so they will need to have lived in the family home from the age of 20 and continue living there until they are 29.

There is a clause allowing a person to sell the home in the six-year window but the full sale price must be used to purchase another home. There is also relief if they are forced to move for reasons of employment.

It does appear you have done a lot to make sure your child is properly provided for in the event of your death

So, in summary, your child should be able to avail of dwelling home relief under the discretionary trust arrangement which means the value of the home would be subtracted from the value of the estate when they inherit in terms of assessing inheritance tax. That means they would only pay inheritance tax if the other cash assets and savings in the estate exceed €335,000.

Grandparents

Finally, on the half of their grandparents’ house that was to come to you but will now likely go to your child, it will be subject to inheritance tax rules.

If they die while your child is still a minor, special circumstances do apply and it will be considered under the category A threshold exemption (€335,000). If they have turned 18, it will be category B (€32,500), which clearly means a bigger inheritance tax bill.

Even under category A, bear in mind that the value of the half of the grandparents’ house as well as the rump value of your estate other than the family home will be totted to see if the threshold is exceeded.

It’s a very difficult position to find yourself (and themselves) in but it does appear you have done a lot to make sure your child is properly provided for in the event of your death.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or email dcoyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice. No personal correspondence will be entered into.

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