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Inheritance Tax - back to basics

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28 April 2015

The Chancellor has hinted that inheritance tax (IHT) cuts are ahead, as he plans to ensure it is only paid by the ‘rich’. What this means in real terms is yet to be seen but with the upcoming election it is expected that the Conservatives will use this as one of their manifesto pledges. In the meantime we go back to basics and look at when IHT will apply and some simple ways an individual can reduce their IHT bill, in a quick-fire Q&A round.

Q. What is IHT and who is affected?

A. IHT is a tax paid on assets left behind on death and on some settlements on trusts or gifts made during lifetime. Individuals who are UK domiciled or deemed domiciled are chargeable to IHT on their world-wide assets. Non-domiciled individuals are only charged to IHT on their UK assets.

Q. What are the rates of IHT?

A. Based on current rates, the first £325,000 of value transferred during a person’s lifetime or on death is taxed at 0%. This is a tax free allowance known as the ‘nil rate band’ (NRB). Chargeable lifetime transfers (e.g. gifts into trusts) above £325,000 within any seven year period are taxed at 20%. The excess above £325,000 passing on death, or gifted within seven years before death, is generally taxed at 40%.

Q. Can the NRB be transferred?

A. Since October 2007 it is possible for spouses and civil partners to transfer the NRB unused on the first death to the surviving spouse for use on their death. This allows the possibility of doubling the NRB available on the second death. In some circumstances, more than two NRBs can be claimed.

Q. When is IHT payable on lifetime gifts to individuals?

A. During a person’s lifetime most gifts are not subject to an immediate charge to IHT but may become due if the donor dies within seven years of making the gift. The IHT charge is based on the value of the gift at the date the gift was made and is taxed at the rates applicable at the date of the donor’s death. Tapering relief may reduce the IHT liability if the donor survives for more than three years but less than seven years from the date of the gift.

Q. Can an asset be gifted but continued to be used whilst still alive?

A. The gifts with reservation of benefit rules prevent an individual making a lifetime transfer of an asset, but continuing to have the use and enjoyment of that asset. If they still use the asset without paying a market rent, the asset will either form part of their estate for IHT or they will be subject to an income tax charge under separate rules.

Q. Are any lifetime gifts exempt from IHT?

A. The following lifetime gifts are exempt from IHT:

  • Gifts between UK domiciled spouses or civil partners with no limit.
  • Gifts to UK registered charities with no limit.
  • Every person has an annual exemption per tax year of £3,000. (This can be rolled orward for one year if unused, but the current year’s allowance must be used first).
  • Small gifts of up to £250 to any number of people.
  • Gifts for family maintenance including the transfer of a property on divorce or the maintenance of dependant relatives.
  • Gifts made as normal expenditure out of income.
  • Wedding gifts (depending on the relationship with the couple):
    • By parents, of up to £5,000
    • By remoter ancestor, of up to £2,500
    • By anyone, of up to £1,000 

Q. Who pays the IHT?

A. Any IHT that becomes due on a lifetime gift, because the donor dies within seven years, is paid by the donee unless the gift is specified as being free of IHT. On death it depends on how the property is held -personally, jointly or via a trust. In most estates, the executor or personal representative is responsible for paying the IHT.

Q. When must IHT be paid?

A. In most cases the IHT bill must be paid within six months of the end of the month in which the death occurred. After this, interest will be charged on the amount outstanding.

It is possible to pay in annual instalments over ten years if the value of the estate is tied up in property, such as a house or unquoted shares.

Q. Are any tax reliefs available for IHT?

A. There are two main reliefs:

  1. Business Property Relief (BPR)
  2. Agricultural Property Relief (APR)

These reliefs effectively remove the value of many business interests and farms from the charge to IHT, subject to detailed conditions being met.

Q. How can an individual reduce their IHT bill?

A. Up front planning is essential to help minimise an IHT bill as far as possible, with a few ideas set out below:

  • Up to date Will in place that has been drafted tax efficiently.
  • Ensure that exemptions and reliefs mentioned above are fully utilised.
  • Consider legacies to charity to reduce the IHT rate from 40% to 36%.
  • Use the NRB in full by making chargeable lifetime transfers of up to £325,000 and lifetime gifts of more than this, as these will fall out of account after seven years.
  • Consider the use of trusts.
  • If assets qualify for 100% BPR or APR, consider passing to children or a trust in order to ‘bank’ the relief.