Techzone

What is IHT?

Inheritance Tax is a tax that may be payable on your 'estate' when you die.

It can also apply to certain gifts made during your lifetime.

Broadly, IHT will be due if the value of your estate on death is greater than your 'nil rate band'.

The standard nil rate band is £325,000, although the amount available to you could be different depending on individual circumstances. If your estate on death is greater than your nil rate band, the excess is typically taxed at 40%.

What is included in your estate?

If you consider your home to be the UK, your estate for tax purposes will be the value of all the assets you own anywhere in the world. This includes your family home, buy to let properties, cars, savings, investments and personal possessions. Your estate on death could also include gifts you made in the seven years before your death. Any liabilities, such as money owed, will reduce the value of your estate.

Pension savings are not, however, normally included in your estate. That's because your pension provider will usually decide where any remaining funds are paid, and not your executors. You will, of course, be able to tell your provider who you wish to benefit.

Exempt assets

There will be no IHT on certain assets in your estate. These include:

• assets gifted to your spouse or civil partner
• assets gifted to charity
• business assets, such as shares in a family business, or other 'unlisted' shares, which you have owned for at least two years
• agricultural property, such as land used for farming and the farmhouse situated on that land

After these reliefs and exemptions have been deducted, the remaining estate over your 'nil rate band' is taxed at 40%.

Nil rate bands

Your own nil rate band

This is currently £325,000, and is fixed at this amount until April 2028. Any gifts made in the seven years before your death will use the nil rate band first, with the balance available to set against your estate.

Transferable nil rate band

If your spouse or civil partner died before you, your executors can claim the unused part of your partner's £325,000 nil rate band. If your spouse left everything to you when they died, you could have up to £650,000 to set against your estate. But money left to others, such as children or grandchildren, can reduce, or wipe out, the amount that can be transferred.

Residence nil rate band

There is also an additional £175,000 of nil rate band which can be claimed if the family home passes to direct descendants (children, grandchildren etc.) on death. Just like the main nil rate band you can also claim any unused part of the allowance from your spouse or civil partner if they died before you. The residential nil rate band has been fixed at £175,000 until April 2028.

This means that individuals could be paying no tax on the first £500,000 of their assets, rising to £1M if they are able to claim unused bands from their deceased partners.

Example

Alan and Jean owned their home jointly. On Alan's death Jean inherited his share of the family home and his will also left all his other assets to Jean.

Alan has not used his nil rate band of £325,000.

His residence nil rate band has not been used as the family home did not pass to direct descendants.

Jean's estate can claim both Alan's unused nil rate band and residence nil rate band. If Jean's estate is to be split between her children Mark and Steven she would have the following nil rate bands;

Main nil rate band £650,000 (2 x £325,000)

Residence nil rate band £350,000 (2 x £175,000)

The residence nil rate band can still be claimed if you no longer own property on your death. This is to allow anyone that needed to sell the home to claim. This could be to go into residential care or move in with relatives or to downsize to a smaller property. However, the additional nil rate band begins to be withdrawn for anyone with assets of more than £2M.

Lifetime gifts

Those who can afford to make gifts during their lifetime can significantly reduce the amount of IHT payable on their estate. A gift you make during your lifetime will not be included in your estate if you are still alive after seven years.

For tax purposes there are four types of lifetime gift;

Potentially exempt transfers (PETs)

The most common type of lifetime gift is an outright gift to an individual. There will be no immediate charge to tax whatever the value of the gift. And it will be completely free of IHT provided you survive it by seven years.

If you did die within this period, however, the value of the gift when made becomes chargeable and is included in to your estate to work out how much IHT is due.

To decide who actually pays IHT, your nil rate band will be allocated to your lifetime gifts first, with any balance used against the assets in your estate at the date of death.

If the value of your lifetime transfers in the seven years prior to your death is less than your nil rate band, then no tax is due on them. But this will mean that more of your estate will be taxable at 40%.

If the value of your lifetime transfers in the seven years prior to your death is greater than your nil rate band, there will be tax to pay on these gifts at 40% on the excess, and this tax should be paid by the person to whom the gift was made. The tax bill can be reduced by 'taper relief', but to claim this the donor must have survived the gift by at least three years. This will also mean that there is no nil rate band left for the estate, and so it will all be taxable at 40%.

Chargeable lifetime transfers (CLTs)

Chargeable lifetime transfers are different to PETs because if they are large enough there could be an immediate tax charge. CLTs are typically gifts into certain trusts (interest in possession trusts and discretionary trusts).

If you make a gift of more than your available nil rate band (while you are alive, this will not include the residence nil rate band or the unused band of a deceased spouse), an immediate 20% IHT charge is made on the excess.

The remaining taxation is very similar to a PET. There will be no further tax to pay if you survive for seven years. And the value of the gift is added back in to your estate if you die within seven years and taxed at 40% if in excess of the nil rate band.

Taper relief is again available to reduce any tax payable. And any tax paid at 20% when the gift was made can be used to offset tax payable on death.

Exempt gifts

Gifts to your spouse or civil partner are free from IHT, as are gifts to charities.

You can also give away up to £3,000 each tax year to whoever you chose without it counting towards your estate if you die. And if you haven't used your annual gifting exemption you can go back and claim an extra £3,000 from the previous tax year allowing an IHT free gift of up to £6,000.

It is also possible to make regular gifts out of your income which will be immediately outside your estate. There is no limit on the size of the gifts provided you have sufficient surplus income from which to make them.

Gifts with reservation

If you continue to benefit from any gifts you make they will not be effective for IHT. For example, if you gave your home to your children but continued to live there rent free this would be a gift with reservation and the market value of the property would remain in your estate.

Calculating the IHT due on death

On death the value of your estate is the total of all your assets less your liabilities, such as any outstanding tax or loans which must be repaid. Added to this will be any PETs or CLTs made in the seven years before death.

There's no IHT payable on any part of your estate which is paid to your spouse/civil partner or is paid to charity. Business property relief can mean certain assets related to a trading company, such as shares in business, are free of IHT. A similar relief applies to certain agricultural property.

Inheritance tax is chargeable at 40% if the total assets not covered by these exemptions are greater than the nil rate band. This will include any transferable nil rate band or residence nil rate band of a deceased spouse or civil partner. PETs and CLTs will have first use of the standard nil rate band in the order in which they were made.

Who is liable to pay the tax depends upon what part of the estate is subject to IHT:

• a failed PET - tax is payable by the recipient of the gift
• a failed CLT - tax is payable by the trustees of the lifetime trust. Any tax payable at 20% when the gift was made can be offset against the tax due on death
• your estate - tax is payable by your executors

The rate of IHT is reduced to 36% where gifts to charity exceed 10% of the value of the estate.

Paying the tax

IHT is normally payable six months after the end of the month in which death occurred. In certain circumstances IHT can be paid in instalments. Grant of Probate entitling your executors to access and distribute your property cannot be obtained until after IHT has been paid.