What is Inheritance Tax (IHT)?
IHT is a tax that can become payable on the value of an Estate when a person dies.
It is also potentially payable on outright gifts made during a person’s lifetime and on gifts to a Trust during a person’s lifetime if the gift is made less than 7 years before death.
The tax rate payable on estates valued in excess of the Nil Rate Band is 40% (subject to relief at a special lower rate where charitable donations are made).
The majority of Estates do not pay any IHT, because there is no IHT charge on Estates valued at less than the Nil Rate Band.
What is the Nil Rate Band?
In the current tax year (2016/17) the Nil Rate Band is £325,000.
So, for example, if the Estate is valued at £400,000 there is no tax due on the first £325,000, but tax is payable at 40% on the remaining £75,000, resulting in a tax bill of £30,000.
What is the “Residential Nil Rate Band”?
In addition to the Nil Rate Band, from April 2017 an additional main residence nil rate band will be available to cover the value of the deceased’s home. Initially the additional nil rate band will be £100,000 per person rising to £175,000 per person by April 2020. The additional band can only be used where the property in question is left to the direct descendants of the deceased and not, for example, to a trust. There will be tapered withdrawal of the additional nil rate band for estates with a net value in excess of £2 million.
Assets passing to a UK domiciled spouse or civil partner are exempt from IHT. This is known as the ‘spouse exemption’.
Since 2007, if the first spouse to die does not use up all their Nil Rate Band (perhaps because they left everything to the surviving spouse), the surviving spouse’s personal representatives will be able to make a claim for unused proportion on the second death.
For example: Mr and Mrs Hughes are between them worth £1m. Mr Hughes dies leaving his entire estate to Mrs Hughes. There is no IHT payable on his death because of the spouse exemption. Mrs Hughes then passes away and leaves her entire estate to her children.
Mr Hughes did not use any of his Nil Rate Band so it is all available for transfer to Mrs Hughes. Subject to making a claim, and assuming the Nil Rate Band on second death is £325,000, Mrs Hughes will have £650,000 of Nil Rate band to offset against the £1m joint estate.
The Estate pays no tax on the first £650,000 and 40% on the remaining £350,000, giving a tax bill of £140,000.
Assets gifted during your lifetime, to individuals or into trust, have the effect of reducing the value of your Estate, provided you survive seven years from the date of the gift.
Gifts to individuals are ‘potentially exempt transfer’ (PETs),
Gifts to trusts are ‘chargeable lifetime transfers’ (CLTs).
If you survive a PET or a CLT by 7 years the gifts become exempt from IHT.
If you do not survive the gift by 7 years, there may still be no tax payable provided the total gift value does not exceed the Nil Rate Band; however, the value of such gifts is added back into your Estate and will reduce the level of Nil Rate Band available to the Estate.
Even so, Taper Relief may be available if you have survived more than three years from the date of the gift, and this acts to reduce the rate of tax payable on the lifetime transfer.
Exemptions and reliefs
Spouse Exemption – all outright gifts to spouses/civil partners domiciled in the UK are exempt from IHT, whether made during lifetime or on death. The spouse exemption is limited to £325,000 if the person making the gift is UK domiciled and the recipient is non-domiciled.
Charity exemption – all outright gifts to qualifying charities, whether made during your lifetime or on your death, are exempt from IHT.
A gift to charity can also reduce the IHT rate from 40% to 36% on the remainder of your chargeable estate.
Regular gifts out of surplus income -any regular gifts made out of excess net income are exempt from IHT. These gifts must not affect your normal standard of living; otherwise the Revenue will deny the claim for this relief.
Annual Exemption – an individual can give away up to £3,000 each tax year. If not used or fully used in one tax year, the unused part may be carried forward for one tax year.
Small Gift Exemption – you can make gifts of £250 to any one individual each tax year. The number of individuals is unlimited.
Wedding and Civil Partnership Gifts – a parent may give £5,000, a grandparent £2,500, anyone else may give £1,000 free of IHT.
Who is responsible for paying IHT?
This depends on the circumstances.
The Personal Representatives are primarily responsible for tax on the Deceased’s Estate, but the trustees of any trust established by the Will and the recipients of any lifetime gifts that become chargeable may also be liable for payment of tax.