Guide to Inheritance Tax
Inheritance tax (IHT) in its modern form dates back to 1894, and the introduction of estate duty. The original thinking was that it was a tax on the very wealthy, but with the soaring rise of property values it now affects a large number of estates, and annually raises over £5bn of government revenue.
IHT is based on the value of the assets in your estate at the date of death and on certain gifts you make during your lifetime. As IHT specialists, we are very aware that inheritance is something that many people prefer not to think about or talk about, not least because plans need to be put in place while the estate owner is alive.
To discuss Inheritance Tax and estate planning with our expert team, contact us today.
Why is IHT planning important?
With a tax rate of 40% on assets outside of the nil rate band, IHT can involve very significant payments to HMRC. The amount of IHT payable depends on the value of the deceased’s estate and also on the value of lifetime gifts made before death.
Inheritance tax thresholds and allowances need to be fully understood to minimise IHT liabilities. The rules are complex, and need professional knowledge and experience to navigate through them. Perrys inheritance tax experts have a proven record of helping clients to make robust plans for keeping potential IHT liabilities as low as possible.
Inheritance tax thresholds
Inheritance tax thresholds are based on a nil-rate band (NRB) of £325,000, with the excess value of an estate subject to a rate of 40%. For an estate with property valued at the average home price in south-east England of £440,000 (April 2022, Zoopla), IHT could be payable on £115,000 of the value of the estate – a considerable sum of £46,000.
However, the introduction of the Residence Nil Rate Band (RNRB) in 2017, created a further exemption which stands at £175,000 (2022/23 figure) if a main residence is left to direct descendants (children or grandchildren) amounting to a total potential exemption of £500,000.
The RNRB is reduced for properties over £2m by 50% of the value over £2m, tapering to zero for properties of £2.35m.
IHT for spouses and partners
Importantly, in normal circumstances, there is no tax to pay if the estate is passed on to your spouse or civil partner. The surviving partner’s inheritance tax allowance then rises by the amount of IHT allowance left unused by a deceased partner, which could amount to £500,000 (£325,000 NRB plus R£175,000 NRB). As a result, a couple can currently leave £1 million tax-free to their children and grandchildren.
IHT exemptions for gifts
You are able to give away a total of £3,000 every year without incurring inheritance tax, and the amount can be split among one or more beneficiaries. If you don’t give the full £3,000 away in one year, you can carry any unused amount forward for one tax year only.
Small gifts allowance
You can give as many gifts of up to £250 per person each tax year, as long as you have not used another allowance for the same person. Gifts of this size can be made to as many people as you like.
Gifts for weddings or civil partnerships
In every tax year, you can give a tax free gift to anyone getting married or entering into a civil partnership. The allowances are
- £5,000 to one of your children
- £2,500 to a grandchild or great-grandchild
- £1,000 to anyone else
The rules allow you to combine a wedding gift allowance with any other allowance, apart from with the small gift allowance. So you could give your child £5,000 when they marry, in addition to £3,000 by using your annual exemption in the same tax year.
What is a gift?
For tax purposes, a gift has to be unconditional. As a donor, you cannot profit from it, or make any stipulations, formally or informally, on how and when it is used, or spent. Failure to comply with this principle can result in gifts failing to be IHT exempt, and result in unexpected tax bills for the recipients of the gifts.
The seven year rule for gifts
Gifts made before you die are normally considered part of your estate. However, the rate of tax can be reduced for any gifts made in excess of your nil rate band, provided you survive for at least 3 years.
|Years before death||Rate of IHT||Rate as % of full IHT rate|
|0 to 3||40%||100%|
|3 to 4||32%||80%|
|4 to 5||24%||60%|
|5 to 6||16%||40%|
|6 to 7||8%||20%|
The tax is payable by the people receiving the gift, and can easily result in unwelcome tax liabilities. One way of planning for IHT on gifts, particular larger gifts, is for the beneficiary to take out a term life assurance policy on the donor to cover the potential tax bill.
Further IHT exemptions
No IHT is payable on gifts to charities, community sports clubs or heritage bodies such as The National Trust or The National Gallery. Gifts to political parties are also exempt.
The 40% IHT rate is also reduced to 36% if at least 10% of the net value of the estate is left to charity.
IHT rates table
|Residence nil-rate band*||£175,000|
|Rate of tax on excess||40%|
|Rate of tax if 10% or more of estate is left to charity||36%|
|Lifetime transfers to and from certain trusts||20%|
|Overseas domiciled spouse/civil/partnership exemption||£325,000|
|Relief on businesses unlisted/AIM companies, certain farmland/buildings||100%|
|Relief on certain other business assets eg farmland let before 1/9/95||50%|
|Annual exemption on gifts||£3,000 per donor|
*Up to 100% of the unused proportion of a deceased partner’s nil-rate band and/or residence nil-rate band can be claimed on the survivor’s death
Estates over £2,000,000: the value of the nil-rate band is reduced by 50% of the excess over £2,000,000
IHT and trusts
Trusts can be used to help minimise IHT liabilities. They are legal arrangements whereby your asset or gift is held by a trustee or group of trustees, for the benefit of a named third party.
When you transfer an asset to trustees, it is no longer yours. As a result, it won’t be counted as part of your estate when you die, reducing the exposure to IHT for your beneficiaries. You can also control how and when money you are gifting is paid out.
The process of setting up a trust is complicated and legislation is subject to change, and needs to be approached with extreme care. We strongly recommend getting professional advice from the Perrys trust experts.
IHT wills and probate
IHT planning involves paying detailed attention to writing your will and understanding issues around probate, which is the process of administering an estate after death. A valid will is a key part of allowing probate to proceed without delays and unnecessary complications.
If you die intestate (ie without a will), Letters of Administration are required to appoint an estate administrator, usually a family member. The distribution of your estate will be according to legal rules rather than the way you may want. The process is complex and can result in delays in getting access to savings and other assets which may be needed urgently by partners and children. For the surviving partner in an unmarried couple, the situation is more uncertain than for married couples and civil partners.
With a valid will, administration of the estate is generally more efficient, and the deceased’s wishes can be upheld. If you have yet to make a will, it is important to do so. Our experts can provide all the advice you need on wills and probate.
Business Property Relief
In certain circumstances, if you are a full or part owner of a business when you die, your estate may be able to claim IHT relief. Business assets form part of your estate and those that qualify for business relief have to be owned by you for at least two years before death.
Assets which qualify for 100% relief are:
- a business or interest in a business
- shares in an unlisted company
50% relief is available on:
- shares controlling more than 50% of a listed company
- land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled
- land, buildings or machinery used in the business and held in a relevant trust
Business Relief is not available for businesses which:
- principally deals with securities, stocks or shares, land or buildings, or in making or holding investments
- are not-for-profit organisations
- are being sold, unless the sale is to a company that will carry on the business and the estate will be paid mainly in shares of that company
- are being wound up, unless this is part of a process to allow the business of the company to carry on
It is essential that you understand which business holdings and assets qualify for relief. As with most areas of IHT planning, professional advice is strongly recommended to make sure you are able to make full and appropriate use of Business Property Relief.
When to pay IHT
IHT is due to be paid within six months of death to the government’s Inheritance Tax account. Failure to meet the deadline will result in interest being charged. However, until probate is completed, the executor or administrator will not know the final amount due, and that can be after the deadline has elapsed.
To minimise the build-up of interest, the government allows early ‘payment on account’ covering at least part of the money that will be due. There will still be interest payable on any outstanding amount, but it will be less than interest on the full amount. Conversely, if the final bill is lower than the amount paid, the overpayment and any interest will be refunded.
IHT400 and other forms
With the aim of accurate reporting on all issues around IHT, HMRC has created a wide range of forms covering multiple circumstances relating to the tax.
IHT reporting was simplified for deaths after January 2022, following advice from HM Treasury’s Office for Tax Simplification. The new, simplified reporting requirements apply to ‘excepted’ estates, which are low value and IHT exempt estates. See the government’s guide to IHT forms here.
The most important forms are:
- Use this form to supply all information required for your Inheritance Tax Account. Its purpose is:
- to allow you to apply for probate
- for confirmation that Inheritance Tax needs to be paid
- for confirmation the deceased’s estate does not qualify as an ‘excepted estate’
A wide range of supplementary forms need to be used together with IHT400. They include the following:
For details of gifts or transfer any assets, including cash, property or land.
For details of all UK assets which were jointly owned with someone else.
For details of houses, land and buildings or interests in land and buildings owned by the deceased.
For details of any National Savings Investments, Premium Bonds, bank or building society accounts that the deceased held in their sole name that was in credit at the date of death.
For details about the deceased’s household and personal goods.
For details of pensions other than State Pension.
For details about any life insurance policies, annuities or investment bonds that the deceased made regular monthly or lump sum payments on.
For details of any shares or stock the deceased owned.
For details of the deceased’s assets outside the UK if they had a permanent home in the UK.
For use if you have included a deduction on form IHT400 for any loans, overdrafts, or money spent on behalf of the deceased that is to be repaid out of the estate.
For a probate summary giving details of assets that became the property of the personal representatives and to apply for a grant of representation.
To be used as part of the probate process if the deceased’s estate is an ‘excepted estate’ which is an estate that does not pay Inheritance Tax and meets other conditions.
To supply estate information for deaths on or after 6 April 2011 and on or before 31 December 2021.
For claiming a transfer of unused nil rate band if the estate is an excepted estate and the whole of the nil rate band is available to transfer.
Inheritance Tax FAQs
What is inheritance tax?
Inheritance tax is payable when a deceased person’s estate is above the IHT threshold at the time of their death, and is subject to a range of reliefs and allowances. The tax raises revenue for the government from the wealth and assets of the deceased, rather than allowing it to be passed in full to members of the family and other beneficiaries.
Is inheritance tax fair?
Arguments in favour of inheritance tax are based on the underlying notion that redistributing wealth in favour of the general population is the right thing to do. Arguments against IHT point to the fact that income has already been taxed when it was earned, and that taxing an estate at death amounts to unfair double taxation. The issue has been debated hard for many years, and opposing views won’t go away. However, as with any UK tax, everyone has the legal right to minimise inheritance tax liabilities.
How much is inheritance tax?
The part of a deceased’s estate which is not exempt is taxed at 40%, the same as higher rate income tax. The tax also applies to lifetime gifts outside of certain limits, with tapered relief applying to gifts made within seven years of death. The 40% rate makes effective planning a high priority for anyone whose estate is large enough to incur liability.
Are married couples exempt from inheritance tax?
Any wealth, property or other assets can pass from one spouse to another on death without any IHT liability. The same is true for couples in a civil partnership. However, for cohabiting couples who are neither married nor in a registered civil partnership, IHT rules are significantly less favourable, and can involve tax on property and assets passed on to the surviving partner.
How can I reduce my inheritance tax bill?
To minimise IHT liabilities, you must take full advantage of available exemptions, reliefs and allowances. Further options to explore are trusts, and using life assurance to reduce the risk of IHT for lifetime gifts. Thorough planning is the key to keeping IHT liabilities as low as possible, but there are no shortage of complexities to take account of. At Perrys Accountants in London and Kent, we offer comprehensive advice on IHT for clients with estates of all kinds.
For expert advice on inheritance tax and estate planning, please contact Perrys Chartered Accountants now