By taking the appropriate steps and getting the proper help, you can avoid paying Inheritance Tax and effectively give away assets and money while you are alive.
This guide delves into the details of inheritance tax and explains the circumstances in which it needs to be paid, as well as giving an overview of any exemptions that may be of use.
Table of Contents
What is the concept of inheritance tax?
Individuals are liable to IHT when they transfer value from their estate during their life and after their death.
When someone dies, IHT is determined by taking into account the total worth of their net estate. This involves working out the value of their assets, and then subtracting any liabilities they have. For illustration:
Property:
- Houses and commercial buildings, as well as plots of land
- Cash
- Anything associated with a business, as well as stakeholder interests
- Items like antiques, jewellery, and furniture that are found in a domestic setting
- Stocks and shares, no matter if they are publicly traded or not
- Automobiles, boats, and aircrafts
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Debts:
A person’s liabilities are comprised of what they owe to others.
- Outstanding mortgages and loans that are due
- Any credit card or past due bills
- Costs associated with a funeral
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When looking at Inheritance Tax (IHT) during one’s life, they will need to think about any CLT (chargeable lifetime transfers). This is a type of ‘gift tax’ which is used in cases such as when a gift is given to a trust. The trust is then typically liable to IHT itself.
Rates of Inheritance Tax:
When a person dies, inheritance tax is imposed at 40% on the value of the estate that is above the individual’s IHT limits. If more than 10% of the estate is donated to charity, then the rate of taxation is lowered to 36%, and tax planning may be helpful in this situation.
In the event that Inheritance Tax (IHT) becomes payable due to a charitable lead trust (CLT) having been created, a 20% rate of IHT shall be applied after taking into account any applicable exemptions and the IHT threshold (nil rate band). Further details about the nil rate band are provided below.
Exemptions and Reliefs for Inheritance Taxation:
When it comes to exemptions, individuals have the option to utilize them while they are alive, as well as when they pass away.
If you are a resident of the UK, any gifts that are given to a spouse or civil partner are not part of Inheritance Tax and are considered an exempt transfer. This exemption has no upper limit, as long as the partner resides in the UK and applies both during life and after death.
Gifts which are directed to charities registered in the United Kingdom and any other country in the European Economic Area, charitable trusts from the UK, and organisations such as political parties, housing associations, and national heritage bodies are all exempted.
On an annual basis, one person can make use of a small gift exemption of up to £250. This exemption is a lifetime one and should be claimed in its entirety; there is no limit on the number of people for whom it can be used.
For a newly married pair, people often like to be generous and so a concession on gifts is provided. Depending on the relationship, this could be up to £5,000 from a mother and father, £2,500 from grandparents and £1,000 from anyone else. This allowance is applied for each marriage/civil partnership.
Every year, individuals can take advantage of a ‘annual exemption’ of £3,000 for lifetime gifts. Accordingly, parents may give up to £3,000 to their children annually. Additionally, if this allowance is not used in one fiscal year, it can be transferred to the following tax year. Still, this carry forward rule only applies for a single preceding tax year, and it cannot be accumulated across several years.
The last form of exemption is named ‘normal expenditure out of income’. It is unlike the other exemptions in that there is no set amount, and the definition of ‘normal’ is different for each person. As long as the gift does not reduce their usual standard of living, it is exempt from Inheritance Tax. This is a very subjective exemption, so each individual needs to be confident that their gifts meet the definition of ‘normal’.
When it comes to reliefs, IHT will be waived on assets worth either 100% or 50% if the correct criteria is met. These are known as Agricultural Property Relief (APR) and Business Property Relief (BPR). Thus, the value of these assets will not be included in IHT calculations.
The inheritance tax limit
After the entirety of the estate’s assets and liabilities have been rounded up, you should contemplate what exemptions and reliefs from Inheritance Tax (IHT) can be applied (as mentioned above). Now, you would subtract the IHT tax threshold that is accessible.
Everyone has access to the Inheritance Tax threshold, also called the nil rate band (NRB), which is £325,000. This amount can be used both at the time of one’s death and while they are still alive. This ceiling is renewed every seven years while the individual is still alive.
The NRB was first established in law in 1986, and the threshold was set at that same amount. Since then, it has gradually risen up until 6th April 2009, when it became fixed at £325,000. This rate is planned to stay the same until 5th April 2028.
People must decide if they can take advantage of the residence nil rate band (RNRB) which is presently set at £175,000. This is possible when a person leaves their home to direct descendants such as kids, grandkids, parents and spouses/civil partners of such descendants. There is a limit to the RNRB however if the value of the individual’s estate is more than £2.35m.
An individual may be able to apply £500,000 of IHT allowances to their estate prior to being subject to a 40% rate of Inheritance Tax.
In the event of the death of one spouse, the NRB and RNRB can be passed on to the surviving partner, yet a limit is imposed when the aggregate worth of the estate amounts to more than £2.7 million.
One’s estate could then be exempt from Inheritance Tax at 40% with up to £1 million in thresholds to use.
When the payment of inheritance tax due?
If your possessions on passing exceed the allowances, exemptions and cut-offs for Inheritance Tax, it should be paid to HM Revenue & Customs (HMRC) within six months of the date of death. Say, a person dies on 16th January, the IHT has to be handed over by 31st July of the same year. If late payment is made, HMRC will add interest to the amount due.
The time limit that administrators assign to executors to submit IHT forms is one year.
Where an estate has assets such as real estate, a stake in a business, or certain types of stock, it is possible to pay an outstanding IHT liability in instalments. This arrangement can be beneficial in cases where an estate has substantial assets but is not able to produce the cash necessary for payment. Instalments can be spread out over a period of 10 years, and interest will be added to the balance each year.
At the moment of sale of the asset on which instalments have been requested, HMRC must be paid the remaining IHT and interest.
In the case that Inheritance Tax is due to be paid, due to creating a charitable lead trust, this payment must be made in the same timescale as if it was due to be paid after death – that is, within the six months following the gift.
What is the seven-year rule in regards to taxation of gifts passed on before death in inheritance?
When the death of an individual occurs within seven years of having made a gift, the value of said gift must be added to their estate. This is due to the fact that, for Inheritance Tax purposes, the gift has not been successful. It is essential to consider two types of unsuccessful gifts when making such calculations.
- Lifetime transfers with a fee
- Transfers that may be exempt from taxation (PETs)
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When a CLT is made by an individual in their lifetime, it is subject to the Inland Revenue’s lifetime rate of Inheritance Tax of 20%. This tax will be applicable if the value of the gift is higher than the annual exemption and the available NRB. If the person dies within seven years of having made the endowment, the value of the CLT will be deducted from the NRB, thereby decreasing the £325,000 available.
Gifts exchanged between two people that are not applicable to any of the exemptions are called Personal Exempt Transfers. These PETs do not fall under the Inheritance Tax during the lifetime of the donor. But, similar to a Charitable Lead Trust, if the donor passes away within seven years, the value of these presents will be subtracted from the Nil Rate Band.
In the event that Inheritance Tax (IHT) is due from failed gifts, taper relief may be utilised to lessen the 40% levy. This kind of relief is only applicable if at least three years have elapsed since the date of the gift. As a consequence, the IHT is reduced by 8% annually starting from the gift date. The table below elucidates the amount of relief accessible:
|
Years between gift and death
|
Taper relief available
|
Rate of IHT payable on gift
|
|---|---|---|
|
0-3 years
|
0%
|
40%
|
|
3-4 years
|
20%
|
32%
|
|
4-5 years
|
30%
|
24%
|
|
5-6 years
|
60%
|
16%
|
|
6-7 years
|
80%
|
8%
|
To avoid Inheritance Tax, some people may give away valuable possessions to close relatives. In order for this to be considered a Potentially Exempt Transfer (PET), there must be no strings attached. This means the donor cannot benefit from the item in the same way as before. If this is not the case, then the ‘Gifts with Reservation of Benefits’ (GWROB) rules will be applied. If so, the value of the asset will still be counted towards the estate of the individual when they pass away.
If a mother, for example, bestows her primary residence upon her two children, but still resides in it as if nothing had changed, GWROB will apply. This can, of course, be reduced if the mother pays market value rent for occupying the home, as a non-family tenant would usually do.
Under circumstances where GWROB is not applicable, HMRC may use alternative anti-avoidance tax measures, such as the Pre-owned Assets rules, that could lead to the donor being subject to an income tax charge in certain situations where they gain from assets which have been given away.
How much can one give as a gift that is exempt from taxation?
It is beneficial to take advantage of any available exemptions that can be claimed during one’s lifetime.
Beginning with the £3,000 annual allowance, it is possible to carry forward any unused portion of this exemption to the next tax year. Note that this carry forward facility is only available for one year, and so any remaining amount will be forfeited. The exemption applies in a sequential order, with the first gifts being counted against the £3,000.
The current year’s annual exemption of £3,000 may be combined with the £5,000 marriage exemption. As an example, a parent could make use of both.
It is possible to make the below gifts without falling under IHT (Inheritance Tax) regulations; this is discussed in more detail in the ‘Inheritance Tax Exemptions and Reliefs’ section.
- A UK-domiciled spouse/civil partner can be given presents of any quantity in a single year without any financial restriction.
- On each grandchild’s birthday, £250 may be gifted in cash.
- It is possible to make charitable contributions.
- On a daughter’s wedding day, a £5,000 voucher could be acquired as a present.
- During the year, up to £3,000 worth of presents can be purchased for all family members for special occasions.
- It is possible to give gifts out of income while still maintaining one’s chosen lifestyle.
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If the presents given between individuals do not exceed the IHT exemptions, they qualify as a Potentially Exempt Transfer (PET). These gifts are exempt from Inheritance Tax when given during life, as long as the donor survives for seven years after the date of the transfer. If the donor does not live for seven years, the PET becomes chargeable. To maximize efficiency in IHT planning, it is beneficial to make the gift early.
Alleviating the Stress of an Inheritance Tax:
Creating an inheritance tax can be an intimidating process, but there are measures that can be taken to make the situation less overwhelming.
To be successful in estate planning, it is important to consider the matter early on. All too often, people ignore the need to prepare, but taking the time to plan ahead will not only ease anxiety but also provide the comfort of knowing that your family will be taken care of.
YRF Accountants can assist you in estate planning and provide you with personalized tax advice and financial planning to make sure you’re taking the right steps. If you are interested, please click here to get in touch with us today.
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