Inheritance tax – on death
Introduction
Death duties have been with us for centuries, in the guise of Estate Duty, Capital Transfer Tax and now Inheritance Tax (IHT). The combination of frozen thresholds and rising property prices have meant more estates than ever are likely to face an IHT bill.
This briefing provides an overview on the main IHT principles with an emphasis on looking at IHT on death. Supporting calculations are included to show the learning points in practice.
Core considerations
- IHT is a tax on the transfer of assets on certain lifetime gifts or on death.
- IHT is only charged on the part of an estate that is the above the tax-free allowance (called the Nil Rate Band) of £325,000.
- There is also a Main Residence Nil Rate Band of £175,000 which is available to anyone who owns a main residence which is passed onto their direct descendants.
- The current rates of IHT on death are 0% up to the nil rate band and 40% on the excess (reduced to 36% if 10% or more of the deceased’s net estate is left to charity).
- UK domiciled individuals are liable to UK IHT on assets they own anywhere in the world. Non-UK domiciled individuals only pay UK IHT on assets that are situated in the UK.
- Most assets will be chargeable to IHT unless they are specifically exempt.
- No IHT is payable on gifts between spouses/civil partners as long as both parties are domiciled in the UK.
- For those who have been married and their spouse/civil partner has died, they will be able to claim the Transferable Nil Rate Band.
- There are also exemptions for those that own business or agricultural property.
- There are various ways to mitigate IHT, including reducing the size of an estate whilst alive by making gifts, with a taper relief if the individual making the gift survives between three and seven years.
- On death, IHT is payable six months after the end of the month in which death occurs. The Personal Representatives of a deceased’s estate must pay any tax they are liable for at the time of probate.
Contents
- Overview
- Gifts to spouse/civil partners and charities
- Nil rate band
- Calculating the value of an estate on death
- Calculating Inheritance Tax due on death
- Charitable donations on death
Overview
An individual’s domicile status will determine whether they are subject to UK IHT or not. IHT applies to individuals who are domiciled in the UK, and it is assessable on their worldwide assets. For those domiciled abroad (non-UK domiciles), the tax usually applies only to assets situated in the UK.
Most assets will be chargeable to IHT unless they are specifically exempt. If any gift is exempt from IHT, it will not be included in the value of the estate when calculating the IHT due.
An individual’s estate can include:
- Their home and any other properties they own.
- Any savings or investments (some types of pensions are excluded from the estate, but other investments including ISAs are taxable).
- Any other assets.
IHT is a tax on the transfer of assets on certain lifetime gifts or on death. This is normally any gift made by someone that results in them being worse off, i.e., suffering a decrease in the value of their estate. The measure of a gift for IHT purposes is always the loss to the donor’s estate and not the amount gained by the recipient. It is worth noting that this is different to the basis of valuation for CGT, which will usually be the market value of the asset at the time of gifting.
As the name suggests, most charges to IHT arise:
- When transfers are made on death.
- When Potentially Exempt Transfers (PETs) become chargeable because the donor has died within seven years of the PET (a failed PET).
- On Chargeable Lifetime Transfers (CLTs) at the time of the transfer and/or because the donor has died within seven years of the CLT.
Gifts made during lifetime are considered in more detail in a separate IHT briefing.
On death, the deceased’s Personal Representatives have to pay any tax they are liable for, including IHT, before a Grant of Probate(where the individual has left a Will); or a Grant of Letters of Administration (where the individual has died intestate), can be issued. In Scotland this is referred to as a Grant of Confirmation. These must be issued before the assets of the deceased’s estate can be distributed. IHT is payable six months after the end of the month in which death occurs.
Gifts to spouse/civil partners and charities
There is normally no IHT to pay if an individual leaves everything to their spouse/civil partner.
Spouses/civil partners are taxed independently of each other. On the death of one spouse/civil partner, it is necessary to value their estate, which only includes the assets (or share of assets) belonging to the deceased. Each spouse/civil partner has the benefit of the nil rate band, exemptions and reliefs, independently of the other spouse/civil partner.
Transfers between spouses and civil partners, whether living together or not, are usually exempt. There is an exception to this when one of the parties is non-UK domiciled.
Where a gift is made from a UK domiciled spouse or civil partner to a non- UK domiciled spouse or civil partner, the amount of the exemption is limited to £325,000. Any value over this amount will be subject to IHT. Gifts made from a non UK spouse or civil partner to a UK domicile spouse or civil partner, will benefit from the full spouse exemption.
There is normally no IHT to pay if the deceased leaves everything above the nil rate band to a registered charity.
The main Exempt Gifts that can be made during Lifetime or on Death are covered separately.
Nil rate band
The first £325,000 of an individual’s estate at death is taxable at zero per cent and is free from IHT. This is called the Nil Rate Band and will remain frozen at this amount until April 2028.
Denis’s net estate is £225,000, as this is below the nil rate band of £325,000, there is no IHT to pay on his death.
Since October 2007, the unused nil rate band of one spouse or civil partner can be transferred on death to the survivor and is known as the transferable nil rate band.
There is also an additional nil rate band which is available on top of the standard nil rate band called the Main Residence Nil Rate Band. It works in a similar manner by reducing the value of an estate that is subject to IHT at the full rate of 40% and can be applied when an individual dies on or after 6 April 2017.
Calculating the value of an estate on death
| Step 1 |
|---|
| Total all the deceased’s assets. |
| Step 2 |
|---|
| Deduct any outstanding debts, this could include credit cards, loans and mortgages. |
| Step 3 |
|---|
| Deduct the value of any gifts that have been made during lifetime. |
| Step 4 |
|---|
| Deduct any UK Charitable donations that have been left in the Will. |
| Step 5 |
|---|
| Deduct the reasonable costs of the funeral. |
For example, Bernie has just died at the age of 78. He is UK domiciled, single (never marries) and leaves his entire estate to his nephew. The total value of his assets are £660,000. He has debts of £8,000 and his funeral expenses are £7,000:
| Total Assests | £660,000 |
| Debts | (£8,000) |
| Funeral expenses | (£7,000) |
| Net Estate | £645,000 |
Calculating Inheritance Tax due on death
IHT is charged at 40% on the excess above the Nil Rate Band (£325,000).
IHT is charged at the full rates in force at the time, however, for lifetime transfers made between three and seven years before death, taper relief is available to reduce the tax liability on those transfers. A full overview of Lifetime gifting/transfers is covered in this briefing.
IHT rates do not apply to each transfer in isolation; the tax is levied by cumulating all transfers for the seven-year period prior to death.
Potentially Exempt Transfers (PETs) are ignored during the donor’s lifetime, however, they are included in calculating the amount of IHT due if the PET’s were made less than seven years before the donor’s death.
On death there are therefore two separate elements to the calculation of IHT.
1. The value of the estate on death, and
2. Lifetime transfers made in the seven years prior to death.
For example, Bernie’s net estate is £645,000. The IHT payable is
| Net Estate | £645,000 |
| Nil Rate Band | (£325,000) |
| Chargeable to IHT | £320,000 |
| Taxed at 40% | £128,000 |
Charitable donations on death
If at least 10% of the net estate is left to a UK charity, the IHT rate is 36%. This is because the donation is deducted from the net estate before the IHT payable has been calculated.
| Net Estate | £990,000 |
| Nil Rate Band | (£325,000) |
| Chargeable to IHT | £665,000 |
| Taxed at 40% | £266,000 |
For Bob to have benefited from the reduced IHT rate of 36%, he would have to have left a minimum of £66,500 to charity in his will (10% of the net estate after NRB). The charitable gift is deducted from the amount liable to IHT, as it is not taxable. This would result in IHT of £215,460 – a difference of £50,540
| Net Estate after NRB | £665,000 |
| Charitable donation | (£66,500) |
| Chargeable to IHT | £598,500 |
| Taxed at 36% | £215,460 |
Where the gift to charity falls short of the 10% of the baseline amount, it may be possible for the deceased’s beneficiary(ies) to increase the gift to charity so that the lower IHT rate of 36% applies to the rest of the estate.