This article first appeared in Law Plain & Simple on 24 February 2014
What is inheritance tax?
Inheritance tax (IHT) is a tax paid on your death based on the value of what you own at the date of your death.
Everything that you own is collectively called your ‘estate’. This includes your house, your personal possessions, money in the bank and anything in which you have an interest, such as your share of a holiday home or a joint bank account.
Sometimes, inheritance tax is paid during a person’s lifetime, but this is outside the scope of this article.
Who pays the inheritance tax?
In most cases, your estate pays the inheritance tax. This means that it comes out of what you leave in your Will.
If you don’t have a Will, then your estate is intestate and passes to your relatives as set out by law.
Inheritance tax therefore reduces the value of your estate passing to your loved ones.
How much inheritance tax will I pay?
Inheritance tax is paid at 40% on what you own over and above the value of £325,000.
This £325,000 threshold is called the ‘nil rate band’.
If your estate is worth less than the nil rate band at the date of your death, you won’t pay any inheritance tax, but be careful about gifting assets away to reduce your estate as you could be caught out – see below.
Are there any exemptions?
Yes. We have outlined the most common exemptions below:
- Spouse exemption: If you have a spouse or civil partner, they will not have to pay any inheritance tax on the value of the estate they inherit from you. They may also inherit your nil rate band (or part of it), meaning that your surviving spouse or civil partner will commonly have £650,000 of nil rate band allowance before inheritance tax is chargeable on their estate on their death. If you and your partner are not married or in a civil partnership, the above does not apply.
- Charities: Charities are exempt from inheritance tax as well. In addition, since 6 April 2012, if you leave 10% or more of your whole estate to charity, a lower rate of 36% inheritance tax applies to your whole estate, instead of 40%.
- Other exemptions: There are a number of other exemptions such as gifts to political parties, gifts for national purpose (such as to a museum or art gallery), and gifts to heritage maintenance funds (such as for the maintenance of historic buildings), but these are outside the scope of this article.
Can I give my assets away to reduce my tax bill?
Yes, but there are rules that apply.
- Small gifts and wedding gifts: You can make small gifts of up to £250 to any one individual during a tax year. You can also make gifts on the occasion of a marriage or civil partnership, the amount of which depends on your relationship to the couple:
- Each parent can give £5,000
- Each grandparent can give £2,500
- Either of the couple can give to each other £2,500
- Any other person can give £1,000
- Gifts out of normal expenditure: You can make regular gifts of your income provided that you are left with sufficient income to maintain your usual standard of living. For example, the payment of school fees or premiums on a life policy for someone else’s benefit. This is a complex area however and it is important to take professional advice if you consider doing this.
- Annual exemption: You can make gifts up to £3,000 in any one tax year and also carry forward any unused amount of this annual exemption for one tax year.
What about the 7 year rule?
If you make any gifts of your estate which do not fall under the exemptions above, you risk the value of these gifts being taken into account in the calculation of inheritance tax payable on your estate, if you do not outlive the gift by 7 years.
Can I give my house away but continue to live in it?
No. If you give your house away but continue to live in it rent free, the value of the house at the date of your death will still be taken into account in valuing your estate for inheritance tax.
This also goes for any other asset that you give away but continue to derive a benefit from. For example, if you give away a valuable painting to your son but it stays hanging on the wall in your house, then it will still be treated as part of your estate for inheritance tax.
I own a business, what about this?
Some types of businesses are eligible for either 100% or 50% relief from inheritance tax depending on the type of business it is. If you are a sole trader or partner in a business for example, your business (or share in it) may be eligible for 100% relief on its value at the date of your death.
Some business assets are however only eligible for 50% relief and some types of businesses are not eligible at all, so it is important to take professional advice.
Likewise, if you own agricultural property such as a farm, this may also be eligible for relief at either 100% or 50% depending on the circumstances.
Inheritance tax is a complex area and this article gives the basics only. If you are concerned about inheritance tax, it is important that you take professional advice based on your particular circumstances.