IHT is a tax on the estate of someone who has died. Most often, an estate will include all property, possessions and money owned by the deceased at their time of death. It is a tax that does not apply to every estate and is only payable by estates with a value greater than the threshold set.
| How much IHT do you pay?
Estates are usually split into two calculations: gross estate and net estate. The gross value of the estate is the total value of all assets combined and is the value of the estate before deducting liabilities such as mortgages, funeral expenses and any debts. The net estate value is total of the gross estate less the liabilities.
The standard IHT rate is currently 40% and this is only charged on the part of your estate that is above the tax-free threshold, which is currently £325,000, also known as the nil rate band. The allowance is directed by the government and has remained the same since 2010.
If the value of the estate is above the £325,000 threshold, the part of your estate above this figure, is likely to be liable for tax at the rate of 40%.
There is normally no tax to be paid if the value of your estate is below the £325,000 threshold, you leave everything to your spouse or civil partner, or you leave everything to a charitable organisation.
Any Inheritance Tax due can be paid from any funds held at the time of death, or from money raised by selling assets within the estate.
| Who pays IHT & when is it payable?
This is done by the person dealing with the estate. It can be paid by the executors (someone taking legal responsibility for carrying out the instructions left by the deceased in their will) or the solicitor dealing with the estate on their behalf.
Inheritance Tax must be payable six months from the date of death. If not, HMRC will charge interest on the outstanding sum. It is possible to pay Inheritance Tax on assets such as property that may take time to sell in annual instalments over a 10-year period.
| Relief and exemptions
Marriage and IHT
If you leave the entirety of your estate to your spouse or civil partner, it will be exempt from Inheritance Tax. For example, if the wife dies first and leaves her entire estate to her husband, no Inheritance Tax will be payable.
Nil Rate Band
As above, every estate has the same tax-free threshold of £325,000. If this allowance has not been fully used when the first spouse dies, you are able to transfer it and the unused part can be used by the surviving spouse. This means that the tax-free allowance available when a spouse dies can be as much as £650,000 if none of the £325,000 threshold was used when the first spouse died, effectively doubling the threshold.
Residence Nil Rate Band
In addition to the additional threshold, there is an additional allowance called the Residence Nil Rate Band. The allowance works in a similar way by reducing the value of your estate subject to Inheritance Tax. If a home is left in your will to your children or grandchildren, it can increase the tax-free threshold by £175,000 from £150,000, which could effectively raise the tax-free allowance to £500,000. It can be any home as long as the surviving spouse lived in the home at some stage before they died and the home is included in their estate, therefore the value of an interest in a buy-to-let property will not qualify.
Every tax year, you can give away some money or possessions which are free of IHT. This means you can give up to a total of £3,000 in a tax year without it being included in your estate therefore potentially lessening your Inheritance Tax. You can give the £3,000 to one person or you can also split the £3,000 between several people, it is important to note that you can carry any unused annual exemption forward to the next tax year but are only able to do this for one tax year.
Each tax year, you can also give a tax-free gift to someone who is getting married and can give up to £5,000 to a child, £2,500 to a grandchild or great-grandchild and £1,000 to any other person. These two can be combined and used together so you can give your child a wedding gift of £5,000 as well as the annual exemption of £3,000 in the same tax year.
Other potential exemptions are gifts to help pay the living costs of a child, an elderly dependent or a child under 18.
7-year rule and Potentially Exempt Transfers
Also known as a PET, a Potentially Exempt Transfer enables you to make gifts of unlimited value which will become exempt from Inheritance Tax (IHT) ONLY if you survive for a period of seven years after the gift was given.
If you do not survive the gift by seven years, the gift becomes a ‘Chargeable Consideration’, and the amount of the gift is added to the value of your estate and Inheritance Tax may be due, however the amount of tax due after your death depends on when you gave it. Gifts given in the 3 years before your death are taxed at 40% as normal, but gifts given 3 to 7 years before your death are taxed on a sliding scale which is also known as ‘taper relief’. If you die within 4 to 5 years, the gift is taxed at 24%, 5 to 6 years at 16% and 6 to 7 years at 8%. No tax is due on any gifts you give if you live for 7 years after giving them, so it is not taxed.