Inheritance Tax : A Basic Guide

Inheritance Tax, often called “Death Duties” is a tax charged at a rate of 40% on the value of an estate which is over the “nil rate band”, which is currently £325,000 (applies from any death after 6th April 2009). This is the current position, which is frozen until the end of the 2014/15 tax year. It is always advisable to think about revising a Will if anything changes in relation to Inheritance Tax in the Chancellor’s Budget.

For example:

X leaves an Estate worth £350,000

£350,000 – £325,000 = £25,000

40% of £25,000 = £10,000 Inheritance tax due.

Not all Estates are subject to Inheritance Tax, such as Low Value Estates, Exempt Estates and where someone is domiciled abroad. This guide also applies to normal domestic Estates and not Estates where there is Agricultural land or any Business premises involved.

Inheritance Tax is complicated, and this guide is a basic run down of potential exemptions and an explanation of how it can apply. This is not meant to be a comprehensive “how to”.

What makes up the Estate?

1. Everything that the person owns outright. e.g. accounts in their name, property, personal effects, including “nominated property” e.g. a private pension, where a person is named as the person who will recieve the benefit of that policy after the policyholder’s death.

2. Joint property. If the property is owned with a spouse or civil partner no tax is payable on property passing by survivorship, whether held as joint tenants (both parties own the property) or as tenants in common (the parties’ shares are defined, e.g. 50/50 or 40/60)

Tax may be payable if the property is owned by two people who are not married/in a civil partnership. If the value of the Deceased’s share exceeds the nil rate band tax is payable on that amount.

3. Settled property. If a person is the beneficiary of a trust where they receive the benefit of the property (e.g rent from a house) but, when they die, that benefit passes to someone else, that property is known as “settled property.” They do not own it but the value of their interest in the settled property it is taken into account when calculating the Inheritance Tax.

4. Gifts with Reservations: This is when someone seemingly gives the property away to someone else but continues to have use of it. The most common scenario is when parents transfer their house to their children but continue to live in it. If planning to do this the person transferring the property should always seek legal advice.

Who Pays the Tax?

The tax comes out of the Estate, minus debts, funeral expenses and legal fees. If the tax is payable on certain gifts made in the last seven years then the person who received the gift has to pay the tax. If they cannot the tax is paid by the Estate.

How can a Will help?

It is possible to assign where tax is paid with careful Will planning. If, for example, Person X has a large Estate with several properties, and knows that Inheritance Tax will apply, they could, for example, state that they wished to leave one property to a grandchild free of Inheritance Tax, as long as there is enough to cover the tax liability available elsewhere.

A Will can also include a charity provision, which can reduce Inheritance Tax by 10%.

How can I reduce Inheritance Tax Liability

Note that the Finance Act 2010 has clamped down on a lot of “loopholes”. This guide is not a guide to be used to avoid tax, but can help in efficient management of an Estate. There are other possible exemptions, but these are the most common.

* If an entire Estate is left to a Spouse or Civil Partner the Finance Act 2008 allows any unused nil rate band to be used by the surviving Spouse or Civil Partner on their death, giving an exemption of £650,000. However, if the marriage was before 1975 there can be potential pitfalls because of how the law was applied at that point.

* Gifts between a husband and wife or civil partners who are both domiciled in the UK. The exception is where one party is domiciled in the UK and one partner is domiciled abroad. Here only gifts up to £55,000 are exempt.

* Gifts to UK-established charities and certain other bodies

* Potentially Exempt Transfers : Most gifts to people (not trusts or businesses) made more than seven years before your death. If the gift is made and the person dies before seven years is up then partial exemption applies. This is a complicated area, which is far too in-depth to be included in a basic guide. If planning this sort of gift you should seek legal advice. This is particularly relevant when parents leave property to children and continue to have an interest in it.

* Gifts to people getting married Up to: £5,000 from each parent of the couple; £2,500 from each grandparent or more remote relative; £2,500 between spouses and Civil Partners to each other and £1,000 from anyone else

*Gifts for maintenance Of current or ex-Spouse, current or ex-Civil Partner; any relative dependent on you through old age or infirmity; and for maintenance, education or training of your children (including step and adopted children) in full-time education or aged 18 or under.

* Any number of gifts up to £250 to each recipient for occasional gifts e.g. birthday and Christmas presents.

*Gifts up to £3,000 in total in each tax year. NB this cannot be used in conjunction with the above £250 gifts.