Understanding inheritance tax and gift tax in the UK
‘A chargeable transfer’ may occur in cases gifts made during your lifetime
Wills, Trusts and tax planning
Inheritance tax (IHT) is charged on the ‘value
transferred by a chargeable transfer’ (section 1, Inheritance Tax Act 1984). ‘A
chargeable transfer’ may occur in cases gifts made during your lifetime, gift
between living persons, or on death.
It is important to note the relevance of where
the beneficiary resides:
· A person whose primary residence is in the UK
is subject to Inheritance Tax on their global estate.
· A person whose primary residence is outside of
the UK is exempt from Inheritance Tax on their non-UK assets.
(*) Finance Act 2021 provides that the
nil rate band is frozen at £325,000 until April 2026.
(**) Any unused nil rate band can be transferred to a surviving spouse or a civil partner so in certain circumstances you can effectively pool the allowances to double your NRB to £650,000.
To fully understand the proceeds of your will
you must first put a value on your estate, this will enable you to then see
what the likely Inheritance Tax liability will be. List everything you own and calculate what
they are worth. Where you share ownership, then you need to calculate the value
of your share. In the case of shared
ownership with a spouse or civil partner, then it is automatically assumed that
it is a half share. Usually pension savings and life insurance policies are
excluded from your estate.
When you have calculated the full value of
everything you own, then you must deduct the total amount that you owe in order
to determine the net current value for your estate.
As an example, if you leave behind an estate
worth £600,000, then the inheritance charge will be £110,000 (assuming no other
reliefs or allowances are available). This figure is calculated as 40% of the
total estate less the NRB (Nil Rate Band), so £600,000 minus £325,000 and 40%
of the difference is £110,000.
You must also consider that your estate is
likely to increase in value over time, so it is worth noting that you could be subjected
to greater tax exposure in the future. It is worth considering the various
strategies available to you that can help either reduce the value of the estate
or increase your NRB, some of these strategies are covered in this guidance,
but if you want to reduce your tax exposure it is worth getting professional
legal advice to take into account your personal circumstances.
Who pays the IHT to HMRC and when?
If there is a will, then usually there will be
an “executor”, this is the person who is responsible for dealing with your
estate upon your death, which is known as probate. Your executor is obliged to
pay Inheritance Tax to the HMRC from the funds generated from the estate prior
to distribution to beneficiaries.
Your beneficiaries would not normally pay tax
on their inheritance, unless they have received gifts prior to your death. In this instance there may be inheritance tax
due. There may also be related taxes to pay should they obtain an income from
their inheritance. For example, if they receive rental income for a house left
to them in a will.
Rules on giving gifts
Whatever you leave when you die is not counted
as a gift, it is part of your estate and will be used to calculate the
Inheritance Tax liability if the estate value exceeds £325,000. Should you wish
to reduce the overall value of your estate and reduce the amount of Inheritance
Tax due, then you might consider giving your assets as a gift. This can help improve the finances of
beneficiaries but requires planning ahead as gifts are split in two ways:
1. Tax free or exempt gifts. There is no Inheritance Tax to pay on gifts
between spouses or civil partners. There
is also no Inheritance Tax on any gifts you give away to charities or political
Every tax year
you are able to give away up to £3,000 worth of gifts without incurring
Inheritance Tax, this is known as an “annual exemption”. You are able to carry
forward an annual exemption to the next tax year, but only for one tax
If you have children getting married, then you can give gifts worth up to £5,000. Grandparents can gift up to £2,500 and anyone else can gift up to £1,000, without incurring Inheritance Tax.
You are able to gift as many people as you want up to £250 per person each tax year, but you must not have used another allowance on the same person.
Another way to
reduce the Inheritance Tax due on your estate is to give away surplus income
that you don’t need. The key to this is you need to demonstrate that you have
more income that is necessary to maintain your current lifestyle. This means
making regular gifts as part of your regular spending, also known as “normal
expenditure out of income”.
2. “Drop out” of your estate after a period of time, typically 7 years. Gifts that do not meet the criteria detailed above are classified as “potentially exempt transfers” (PET). This means that Inheritance Tax is not payable now, but could be at some point in the future. PETs that become chargeable to Inheritance Tax are known as “failed PETs”.
You do not incur
tax on gifts as long as you live 7 years after the giving, unless the gift is
part of a trust. However, if you pass away within the 7 years then the gift is
subject to Inheritance Tax, this is known as the “7-year rule”.
Gifts given during the last 3 years of your life are taxed at 40%, and after that they are taxed on a sliding scale known as “taper relief” until the seventh year.
Here is an illustration of the different rates of Inheritance Tax depending on how long death occurs after the gift is received:
Certain business transfers are eligible for up to 100% Business Property Relief. Farmers also receive very generous Inheritance Tax breaks known as Agricultural Property Relief.
There are also other ways to reduce tax
liability, if you want advice relating to any of the points covered in this
guidance please contact Yuliya Shved at: firstname.lastname@example.org or Dr Clifford J Frank at: email@example.com.