When someone dies, often they leave an estate. The estate includes any property, possessions, and money that they owned. This estate is subject to a tax called Inheritance Tax.
How much inheritance tax someone must pay is dependent upon how much the estate is worth. The value of an estate incorporates all financial assets: property, investments, businesses, cash in bank accounts, life insurance payouts, and vehicles. Any liabilities and debts are settled, and the estate value is then calculated.
What is the Threshold for Inheritance Tax?
Importantly, not everyone will need to pay inheritance tax (IHT). There is a threshold value for all estates. For those estates that are below this value, there is no inheritance tax to pay. Also, you will not have to pay inheritance tax:
- If the estate’s value is less than £325,000, or
- If you leave everything above the threshold to a spouse, civil partner, amateur community sports club, or a charity.
Anything else above the £325,000 threshold will be subject to a tax of 40% when you die. This is reduced to 36% if 10% of the estate’s net value is left to charity.
Who Pays Inheritance Tax
In the current 2020-2021 tax year, everyone can leave an estate with a value of up to the £325,000 threshold without paying inheritance tax. However, this still needs to be reported to HM Revenue and Customs (HMRC).
In 2015, the government decided that when a grandparent or parents passes on their primary residence to their direct descendant (i.e. a child, step-child, or grandchild), there is no inheritance tax to pay unless the property value exceeds £1 million (£500,000 for single people). This additional tax-free allowance of £175,000 is called the Residence Nil Rate Band or RNRB. The tax-free allowance threshold on other assets remains the same.
If an estate is worth less than the threshold of £500,000, the beneficiaries do not need to pay inheritance tax. This is the ‘nil-rate’ inheritance tax band. As mentioned, anything that exceeds the threshold has a tax rate of 40% (or 36% if a minimum of 10% is left to charity).
Let us look at an example:
It is July 2020, and a relative has just died. She owns one property and other assets that have a total net value of £525,000, which are left to her son. She did not leave anything to charity. There is nothing to pay on the first £500,000 as it falls into the nil-rate band. There is a 40% tax to pay on the remaining £25,000, which means an inheritance tax bill of £10,000.
Are married or civil partners exempt?
If all assets are left to a spouse or a registered civil partner, as long as you live in the United Kingdom, there is no inheritance tax to pay. Additionally, the remaining living partner’s inheritance tax allowance increases by any portion that the deceased did not use. This means that a couple can leave £1 million tax-free if they leave it to each other.
Let us take another example:
Mr and Mrs Moneybags have a total estate that is worth £1 million between them. Mr Moneybags dies in July 2020 and he, therefore, passes on his tax-free allowance of £325,000 to his wife in addition to his primary residence allowance of £175,000. This means that Mrs Moneybags now has a total tax-free allowance of £1 million: her inherited £500,000 allowance from her deceased husband and her own personal £500,000 tax-free allowance.
To have this doubled-up tax-free allowance upon a partner’s death, you do not need to register or activate anything. After a death, the executors need to send specific documents to HM Revenue & Customs (HMRC).
If someone gives money, property, or other assets to another person before they die, this is usually still counted as a part of the estate. The people given then gifts will subsequently be subject to inheritance tax (of up to a 40% maximum limit) if more than the £325,000 threshold is gifted within the seven years before the death. It is essential, therefore, to plan how to pass on your assets early.
If you intend to give more substantial lifetime gifts, those receiving the gifts can take out life insurance to mitigate the potential tax bill. Even gifts in the trust are also subject to IHT. For trusts, it is essential to seek professional and specialist advice.
Small gifts such as those for birthday or Christmas gifts that come from your regular income are known as ‘exempted gifts’, and there is no tax to pay on theses. Likewise, any gifts between civil partners or spouses are exempt throughout your lifetime if there is permanent residency in the UK.
Additionally, you can also give £3,000 in total each tax year as a gift without this being added to an estate’s value should you die within seven years of the gift-giving. This is called the ‘annual exemption’. You can also carry forward any annual exemption that has been unused in a tax year, but this is only possible for one year.
There are also other exemptions in each tax year. You can give away:
- up to £5,000 for a child, £2,500 for a grandchild or great-grandchild, and £1,000 for anyone else as a wedding or civil ceremony gift
- living cost payments for someone else such as those for a child or elderly relative
- charity gifts or gifts to political parties
- smaller gifts of up to £250 to anyone else as long as they do not fall into one of the other exemption categories.
You can also apply these exemptions to the same individual. In one tax year you could give a grandchild a birthday, Christmas, and wedding gift without it counting toward the estate should you die within seven years. All other gifts will count towards the estate in the event of a death.
Taper Tax Relief on Gifts
As mentioned, if you give a gift and then die within the next seven years, these assets may be subject to inheritance tax if the estate is above the threshold value of £325,000. There is a tax-relief taper which can reduce the inheritance tax bill, which depends on when the gift was given.
If an estate is subject to inheritance tax, any gifts given within the last three years are charged the 40% IHT rate. Gifts given more than three years ago but less than seven years ago are charged the tax on a ‘taper relief’ sliding scale.
|Years between gift & death||Tax paid|
|less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
Usually, the funds of the estate pay the inheritance tax bill to HMRC. This is undertaken by an executor if there is a will in place. The beneficiaries do not pay tax on what they inherit, but there could be additional taxes if they receive income from renting an inherited property. Thankfully, there is much help out there in dealing with inheritance tax when someone dies.
You can find more information on the government’s website here.
Do not put your financial plans on hold. Please consult one of our inheritance tax solicitors who can provide you with expert legal advice on all matters around estate planning to protect you & your family. They can help you find a solution quickly and efficiently.
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