Inheritance Tax (IHT) is a tax that we commonly associate with death; it is one of the key things executors have to deal with when someone passes away.
IHT can also apply on lifetime transfers (gifts), on transfers into and out of trusts and on some transfers made by or to certain companies. A transfer will either be a chargeable transfer, a potentially exempt transfer (PET) or exempt from IHT all together.
In this blog, we will focus purely on the charge to IHT on death, as well as lifetime gifts made by individuals.
Charge to IHT on death
Who pays IHT?
When someone dies, the estate is liable for IHT, which is usually payable at 40% above the available nil-rate band. Executors of the estate are responsible for submitting the IHT return to HM Revenue & Customs (HMRC) and paying the tax, which is made from the deceased person's estate. Once the tax has been paid, Probate is then granted which allows the assets of the estate to be distributed to beneficiaries.
What is the current IHT Nil Rate Band?
The current nil-rate band is £325,000 for an individual. Where assets are passed between partners in a married couple or a civil partnership, the transfer on the first death is generally exempt from IHT and the unused nil-rate band can be passed to the surviving spouse or civil partner on death.
If one partner has already died, the allowance could therefore be as high as £650,000 on the second death, but will depend on how much of the allowance was used on the first partner's death (for example where part of the estate was left to someone other than their spouse).
In April 2017, HMRC introduced an additional nil-rate band when a residence is passed on death to a direct descendant.
How does the residence nil-rate band work?
The residence nil-rate band applies where individuals pass their main residences to direct descendants like children or grandchildren. As only direct descendants can benefit, not everyone will be able to rely on this additional nil-rate band for IHT planning purposes.
The new nil-rate band is currently £150,000 in the 2019-20 tax year before reaching £175,000 in 2020-21.
It should be noted that some estates will find that residence relief is tapered/reduced; it is reduced for estates worth over £2 million.
Lifetime gifts
What is the 7-year rule, and how does it work?
To reduce the amount of IHT payable, many families consider giving their assets away during their lifetime. These are called 'potentially exempt transfers'. Provided the individual survives at least 7 years after making the gift, the asset given away is no longer considered in calculating the IHT due on death.
If an individual dies within 7 years, the value of the gifts reduces the available nil-rate band on death.
If the gifts are worth more than the nil-rate band, IHT is chargeable on the excess at 40%, but taper relief applies so that if an individual passes away at least 3 years after the gift is made, the tax liability is reduced.
Gifts must be made outright, and the individual making the gift cannot continue to benefit from them. For example, if an individual were to gift their home, but continue to reside there without paying a commercial rent, HMRC would consider this to be a 'gift with reservation of benefit' and the house would be included within the value of the estate.
What Gifts are Exempt from IHT?
Individuals have an annual exemption for IHT, so they can make gifts of up £3,000 (in total, not per recipient) per tax year. If the exemption is not utilised in one tax year, it can be carried forward to the next year, for one year only.
In addition, the following exemptions are also available:
Gifts of up to £250 per person per financial year to any number of people are exempt.
Each parent of a bride or groom can give up to £5,000; grandparents or other relatives can give up to £2,500 and any well-wisher can give £1,000.
Gifts to registered charities and political parties are also exempt from IHT.
There is also a way of passing money to the next generation which allows for gifts to be made from surplus income. There are a number of criteria that apply to this exemption, and advice should be sought to ensure that the gifts are made in the right way.
Contact Us
Please contact us to find out how the above applies in your circumstances and how you can reduce your tax liabilities and maximise your tax efficiency.
Please note that the above is for general information only and does not constitute financial or tax advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation.
