Inheritance Tax is a tax on the Estate (property; money; possessions; etc.) of someone who has died.
The Nil Rate Band (NRB)
Each person is given an allowance, known as the nil rate band (NRB), whereby no inheritance is charged on that amount. The current allowance is £325,000. Anything above the NRB is subject to 40% inheritance tax.
The Transferable Nil Rate Band
Couples who are married or in a civil partnership don’t pay any inheritance tax on anything they leave to each other. Their unused allowance (or what is left of it if they leave assets to beneficiaries other than their spouse) can then be transferred to the surviving spouse on their death. This means married couples or couples in a civil partnership have a combined allowance of £650,000 which can be left free of inheritance tax.
The transferable NRB is not automatically given to the Estate on your death. Your Executors must file certain forms to HMRC to apply for this relief to be applied to your Estate.
The Residential Nil Rate Band (RNRB)
The RNRB is in addition to the standard nil rate band (NRB) and takes the form of an extra amount that can be offset against the value of property (land and buildings or possibly assets representing them) that has at some point been occupied as a residence. A property previously occupied and then let will still qualify. A property that has always been let, e.g. a buy to let, will be excluded.
The additional RNRB will be available if all or part of a “qualifying residential interest” is “closely inherited” on or after 6 April 2017, usually on the death of the owner. The definition of “closely inherited” is when a property is transferred to a direct descendent and this is defined as a child, including step-child, adopted child, or foster child and grandchildren. Any person who is a minor is treated as direct descendant of anyone appointed as that individual’s guardian.
The gift can also include gifts via a trust in certain defined circumstances. The transfer to direct descendants must be outright but some transfers on death into trust for the benefit of these descendants are permitted, transfers into bare trusts, transfers into immediate post-death interest trusts (life interest trusts), transfers into 18-25 trusts, trusts for bereaved minors and trusts for disabled persons.
You cannot claim this allowance if the property is going into a Discretionary Trust (this includes lifetime Asset Protection Trusts).
The RNRB has been phased in gradually from 6 April 2017 until 6 April 2020.
* £100,000 for 2017/18
* £125,000 for 2018/19
* £150,000 for 2019/20
* £175,000 for 2020/21
* From 6 April 2021 the RNRB will increase in line with the consumer price index.
The amount of the relief shown above is the maximum available. This will be limited by reference to the value of the residence net of any mortgage charged on it. The relief is set against the gift of the residential property and will not be applied to the charge on the Estate generally. Married couples and civil partners are able to carry forward RNRB that was not used when the first partner died.
The transfer to direct descendants can be by Will, under an intestacy (dying without a Will) or as a result of survivorship. Care must be exercised as to whether assets do form part of the deceased’s Estate before they are inherited. For example, gifts with reservation of benefit made during lifetime will qualify under the new regime as these are regarded as still part of the Estate on death.
There is a provision to cover the situation where after 8 July 2015 (when the legislation was announced) the deceased had downsized to a less valuable residence or had ceased to own a residence that part will still be available as long as the deceased left a smaller residence or assets of equivalent value to direct descendants.
Taper relief will apply where the deceased’s Estate after deducting liabilities (but before reliefs and exemptions) exceeds £2m. The RNRB will be reduced by £1 for every £2 excess value. The threshold will also increase in line with Consumer Price Index (CPI) from 6 April 2021.
If death occurs after 5 April 2017, the RNRB will first be set off against any chargeable transfers of a family home before the standard NRB. Any RNRB that is not used on the 1st death can be transferred in full to the Estate of the survivor unless that Estate exceeds the taper threshold (£2m).
If there is more than one qualifying residence, the personal representatives can nominate one of them to be the qualifying residence for the RNRB. Claims for RNRB must be made within 2 years of the death.
This is a very complicated relief and Executors should always seek professional assistance when dealing with Probate to ensure the maximum amount of reliefs available are claimed.
- Small gifts to individuals not exceeding £250 in total per tax year per recipient are exempt from inheritance tax. The exemption cannot be used to cover part of a larger gift.
- Gifts between spouses and civil partners are generally exempt unless one spouse is domiciled abroad in which case it is limited to £325,000 forever and anything above this is a potentially exempt transfer.
- £3,000 per annum may be given by an individual without an inheritance tax charge. An unused annual exemption may be carried forward to the next year but not thereafter.
- Gifts for a wedding or civil ceremony of up to £1,000 per person (£5,000 if the gift is to your child, £2,500 if they are a grandchild or great-grandchild).
- Gifts of a value higher than £3,000 will be potentially exempt transfers (PETs) potentially exempt from inheritance tax provided you live for seven years after making the gift and do not retain a benefit.
For the gift qualify it must be made after 18 March 1986, by an individual, to another individual or into a disabled persons Trust.
After three years taper relief reduces the rate of tax charged on that transfer.
To work out the taper relief, you first work out what the value of the tax payable on that gift would normally be (currently 40% of the gift). Then you work out what taper relief on the gift would be and deduct this from the previous valued you worked out.
The current rates of taper relief associated with these gifts are:
Time between date of gift and death:
Taper relief applied to tax due:
3 to 4 years
4 to 5 years
5 to 6 years
6 to 7 years
At your death you go over the inheritance tax threshold and therefore tax is payable on a gift of £10,000 which you gave your son three years before you died.
First work out what the tax would normally be (40% of £10,000 = £4,000)
Then work out what the tax would be based on the taper relief (20% of £10,000 = £2,000)
Then you deduct the taper relief from what would normally be payable (£4,000 minus £2,000) which means there would be £2,000 tax to pay on the gift.
After seven years lifetime gifts become fully exempt and fall outside of your estate for inheritance tax purposes.
If, at your death, your estate goes over the inheritance tax threshold, your executors will need to declare any lifetime gifts you made within the previous seven years of your death when they apply for the Grant of Probate (see our Probate page).
If they are not declared and HMRC subsequently find evidence of any such transfers then your executors will be liable to pay the tax owed if it cannot be claimed back from the recipient(s) of the gift(s).
Gifts with reservation of benefit
For gifts to fall out of your estate you must live for seven years and must not retain a benefit in the gift.
If you gift a property but continue to occupy it or enjoy the rental income it produces, it is a gift with reservation of benefit and will remain within your estate for inheritance tax purposes regardless of the seven year rule.
Excess income over expenditure
Gifts made out of surplus income may be exempt from inheritance tax. Income means salary; the returns from self-employment; rent received; commissions; dividend income from shares; interest paid on a bank /building society account.
If income was originally from an income source which has become a capital source then HMRC may refuse it. We consider income becomes capital after two years unless there is evidence to suggest otherwise.
Gifts made from capital contents of a purchased life annuity or any surplus income arising from a discounted gift trust where you draw down 5% per annum from the trust would not qualify as excess income over expenditure.
The rules regarding this have to be satisfied for the revenue to accept it.
The gift must be made as part of ‘normal expenditure’, derived from income and the transferor must be left with sufficient income to maintain their usual standard of living.
‘Normal expenditure’ means you must show expenditure which, at the time it took place, was consistent with the usual spending pattern.
You can show this by examining the expenditure over a period of time which may show a pattern (for instance a regular payment of 15% of your income every year) or you can show it was ‘normal expenditure’ by establishing the assumption of a commitment or intention regarding future expenditure and thereafter complying with it (which will then in due course show a pattern).
There is no fixed minimum term however page 6 of the revenue’s IHT403 form sets out the required evidence and should be completed properly from the start and a new one made each year, you must ensure each one is kept and submitted as supporting evidence when the time comes.
The gifts should clearly be documented; therefore you should write a letter to the intended beneficiaries with your intentions and copies should be kept.
Annual exemption; maintenance of dependents and surplus income can all be claimed.
Maintenance of Dependents
Income can be applied between spouses or civil partners for their maintenance; to a child or spouse’s child for their education, maintenance or training up to 18 or until their full-time education or training comes to an end; and to a dependent relative. As long as it constitutes reasonable care and maintenance then as such will not be seen as gifting and therefore falls outside of your estate for inheritance purposes.
Reducing the inheritance tax bill by leaving 10% of net estate to Charity
This information has been taken directly from gov.uk.
To encourage people to leave part of their estate to charity, where at least 10% of a person’s net estate is left to charity, the rate of tax charged is reduced to 36%.
In the legislation the word charity has the normal meaning for Inheritance Tax purposes and includes registered community amateur sports clubs and organisations in the European Economic Area that meet the requirements for being a charity. The reduced rate of tax only applies to charges that arise on death.
The reduced rate only applies to deaths occurring on or after 6 April 2012.
In order to qualify for the lower rate; the donated amount must be at least 10% of the baseline amount.
The ‘donated amount’ is defined as the amount of the component which is attributable to property that qualifies for charity exemption. This could be a legacy of a specific amount, a share of the residue, or a share of the estate that is quantified so as to ensure the estate, or a component of the estate, will meet the 10% test.
The calculation for the ‘baseline amount’ is, broadly, the value transferred by a chargeable transfer, but after adding back the amount that qualifies for charity exemption.
Components of the estate:
A person’s estate for Inheritance Tax (IHT) is made up of all the property to which they are beneficially entitled, so there may be a number of chargeable elements to the estate, which is described as ‘components’ of an estate. The reduced rate applies separately to each component that makes up an estate, so it is possible that one component may bear tax at 36% whilst others pay tax at the full rate.
For the purposes of applying the reduced rate, the aggregate estate on death into three components:
Property held jointly as joint tenants
Settled Property Component:
Property held in a trust that is treated as part of the estate for IHT purposes
All other property in the estate, other than property included in the survivorship and settled property components.
It is possible for one or more components to be merged so that the combined component qualifies for the reduced rate.
Property in which a reservation of benefit subsists is eligible to be merged with other components, even though it is not specifically identified as a component of the estate.