Understanding Inheritance Tax for Business Assets

Navigating the complexities of inheritance tax can be overwhelming, especially if you’re a business owner. Not only will you want to pass down your assets in the most tax-efficient way, but you also need to consider the legacy you want to leave for your business. Whether you want to pass on your business to family or sell it during your lifetime, understanding how inheritance tax applies to business assets is crucial for effective financial planning and preserving your hard-earned legacy.

As a business owner, you have the added complexity of considering what will happen to both your personal and business finances after you’ve gone, and having a clear financial plan that considers both is essential for ensuring long-term stability and achieving your succession and retirement goals.

Inheritance Tax considerations for Business Owners

There are several key considerations that business owners must take into account when it comes to inheritance tax planning. Firstly, the structure of the business plays a crucial role in determining how inheritance tax is applied. Sole proprietorships, partnerships, and corporations each have different implications for tax liability. For example, in a sole proprietorship, the entire value of the business is included in the owner’s estate, while in a corporation, only the shares owned by the deceased are considered, which can sometimes offer more favourable tax treatment.

Another factor to consider is the timing of succession planning. Business owners should start thinking about their estate plans well in advance of their passing. This involves not only determining who will take over the business but also how to best structure the transition to minimise tax liabilities. Early planning can involve setting up trusts, making gifts, or restructuring the business to take advantage of various reliefs available for business assets.

If you want to step back from managing the business during your lifetime, you might consider transferring it to a family member. However, they may not necessarily have the skills or desire to take it on, making succession planning – both in the event of retirement and if unexpected circumstances were to arise – very important.

Effective tax planning for business owners

Tax planning plays a vital role in protecting as much of your wealth as possible during your lifetime and for those who may benefit from your estate in the future. Here are some key points to consider:

• Trading businesses benefit from 100% business relief, making them largely exempt from Inheritance Tax (IHT). This means that if you were to pass away while still owning your business and it is included in your estate, it wouldn’t attract IHT, provided all eligibility criteria are met.
• However, changes are coming into effect on 6 April 2026. From this date, the current 100% rate of agricultural and business relief will be limited to the first £1 million of combined agricultural and business property, with relief dropping to 50% for anything above this threshold.

Selling your business during your lifetime

If you decide to sell your business during your lifetime, you will need to carefully consider the following:

1. The recent Autumn Budget brought in changes for Business Asset Disposal Relief (BADR). The current 10% rate on the first £1m of qualifying disposals will increase to 14% in April 2025 and again to 18% in April 2026.
2. On disposal, you may have brought a large amount of capital into your personal estate that wasn’t there before, and this could be liable for IHT when you die.
3. You’re likely to have been drawing a healthy income from your business, so you need to think about how you’ll replace that in an IHT-efficient way that also gives you security over a long period of time, to ensure you don’t run out of money.

Protecting your business assets from Inheritance Tax

There are several ways you can mitigate your business assets from Inheritance Tax, including:

• Setting up Trusts

Trusts allow business owners to separate ownership of their assets from direct control. This helps ensure that the business capital is protected from risks such as creditors and legal claims. It can also reduce tax when you pass away or you decide to pass your business on – which is why they are used by many types of businesses.

Trusts can enable business owners to specify how the business capital will be distributed among beneficiaries. This can ensure a smooth transfer of wealth, even if some family members are not directly involved in the business.

• Annual gifting allowance

The annual gifting allowance is a valuable tool for business owners looking to reduce the potential Inheritance Tax (IHT) liability on their estate. Here’s how it works and how it can help:

You can gift up to £3,000 per tax year without it being subject to IHT. This allowance can be carried forward for one year if unused, allowing business owners to potentially gift up to £6,000 in a single tax year.

Business owners can also make gifts out of surplus income (e.g., dividends, salary, or rental income), provided these gifts do not impact their standard of living. Such gifts are exempt from IHT under the “normal expenditure out of income” rule, which helps further reduce the estate’s value.

• Pension contributions

Pensions are currently exempt from Inheritance Tax, but the Autumn Budget announced a proposal that from April 2027 most unused pension pots and death benefits will be subject to Inheritance Tax. Despite this, pensions are still the most tax-efficient way to save for your retirement.

The Government has been clear that the current spousal IHT exemption that applies on transfers on death to spouses or civil partners will not be affected by the proposed changes. It is therefore important to ensure you have set up the relevant beneficiaries for your pension fund to safeguard it from Inheritance Tax.

• Capital Gains Tax (CGT)

If you gift your stake in your business to your children or another family member, they’ll inherit the base cost if you use Gift Hold-Over relief. That allows you to move shares around the family without having to worry too much about CGT, as you’re effectively deferring the liability.

When it comes to protecting your business, and your family, and you want to ensure a smooth transition of your assets to future generations, remember that financial planning is quite different to legacy planning. A financial plan ensures that your finances are optimised for your lifetime, while a legacy plan ensures that your wealth and business are passed on smoothly and tax-efficiently, reflecting your wishes after your lifetime. Both are essential for a comprehensive approach to managing and securing your wealth as a business owner.

If you’re a business owner looking to protect your hard-earned wealth and ensure your business’s legacy is secured for the future, we’re here to help. We have helped many business owners minimise tax liabilities while preserving business value.

Book a call with our advisers to make sure everything you’ve built is set up to benefit the people and causes you care about most – both now and in the future.

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Trusts are not regulated by the Financial Conduct Authority.

Although the content of the article was correct at the time of writing, the accuracy of the information should not be relied upon, as it may have been subject to subsequent tax, legislative or event changes.