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What is Inheritance Tax?

Inheritance Tax normally shortened to IHT is the tax that is paid on someone’s estate when they have passed away. This is done by working out the value of the estate. To do this we need to locate all the assets being money in bank accounts, household possessions, jewelry, and land or property to name a few.

We need the value of these assets as of the date of death and this can be done by contacting the various financial institutions and valuers e.g. estate agents. From this figure, we then deduct all the liabilities including the funeral expenses, credit card balances, mortgages, etc to determine the net estate.

Once we have the net estate, we can apply any exemptions that may be available on the particular estate and once this has been applied it will leave a value of the estate that may be liable to inheritance tax.

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How much is Inheritance Tax?

Once the estate has been valued as stated above, inheritance tax would only be paid if the value is above the current threshold of £325,000. So, anything under this value would not be liable to the tax.

However, if the estate is above this threshold of £325,000 then the tax would be levied at 40% on the amount that is above the £325,000 threshold.

How do you pay inheritance tax?

A Personal Representation is the general name given to the person who takes charge of the estate. If there is a will in place then he or she is known as the “Executor” and if there is no will i.e. the person died “intestate” then that person will be known as the “Administrator”.

They have certain duties to fulfill under this role and one of which is to report the value of the estate to HMRC and to arrange to pay the inheritance tax and all the other taxes due in the estate.

If a grant of probate (if there is a will) or letters of administration (if there is no will) is required in the estate, and it is a taxable estate, the personal representative will need to make arrangements to pay the inheritance tax before they submit their application to probate.

This will also depend on the assets of the estate, if there is no property involved, the executor will have to pay the whole of the tax before applying for probate. If there is property, they can opt to pay the a tenth of the tax known as the “instalment option”.

This is due at the end of the sixth month from the date of death. HMRC will apply interest on the amount owing after this date. Arrangements can be made to have the tax paid from the deceased bank account directly to HMRC.

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Inheritance Tax Exemptions

An overview of the exemptions and relief available on inheritance tax.

  • As mentioned previously, an estate worth under £325,000 is free from inheritance tax – this is known as the “Nil Rate Band”.
  • Spouse or civil partners do not pay inheritance tax on anything left to them. This is known as “Spouse exemption”. So, this means that if they were to leave their whole estate to each other, when the second person dies the two lots of nil rate band would be available to apply to the joint estate, thus £650,000 free of inheritance tax.
  • Gifts or shares of the estate left to any registered charity will be free of inheritance tax.
  • Also, if at least 10% of the estate has been left to a registered charity, the rate of tax applied to the taxable portion of the estate would drop from 40% to 36%.
  • Business Property Relief can be applied to an estate if the deceased had owned a “trading” business and this is now left to beneficiaries. If successful the whole value of the business would be free of inheritance tax.
  • A recent addition to the list is the “Resident Nil Rate Band”. This gives an extra allowance of £175,000 from 6th April 2020 to be applied to the deceased’s estate if a property was owned and left to “linear descendants” being children, grandchildren but also stepchildren, adopted children, and foster children. The same applies to the nil rate band, if this is not used upon the death of the first spouse it the whole or unused amount can be added to the estate on the second death so that a potential value of £350,000 can be deducted in one go.

Both the Business Property Relief and the Resident Nil Rate Band are complicated pieces of legislation and it would be best to seek a solicitor’s advice on applying for these exemptions.

Inheritance Tax on Gifts

When a gift is made in an individual’s lifetime and the value is over £3,000 an imaginary clock will start ticking. When 7 years have passed from the date that the gift was made, then the value of this gift will not be taken into account when calculating the inheritance tax due of the person who made the gift should he or she die after the 7 years.

If he or she does pass away within the 7 years, then it will fall into account and depending on the value of the gift it may be deducted as part of the Nil Rate Band value.

If not, depending on how long after the gift was made, the person died, the tax rate would be reduced from 40% to a lesser amount of 32%, 24%, 16% or 8% this is known as tapering relief on IHT.

The following gifts can be made annually without incurring taxes – Annual Exemption:

  • Gifts of up to £3,000 to an individual in any tax year.
  • Any unused annual exemption can be carried to the following year but this is limited to one year only.
  • Gifts to someone getting married or civil ceremony. A child £5,000, a grandchild or great-grandchild £2,500 and £1,000 to anyone else.
  • Gifts of £250 to any person provided that you have not used any of the other exemptions listed.
  • Gifts out of your income given regularly say for birthdays or religious festival but you must maintain your standard of living and not resort to changing your lifestyle.
  • Gifts to charities and political parties.
  • Payments to help with the living costs of a dependant say a child under 18 years or an elderly relative.

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