How does Inheritance Tax work?
Our estate planning solicitors have created this article to guide you through the intricacies of inheritance tax, what it is and when you are expected to pay.
What is Inheritance Tax?
When a person dies, a percentage of the total value of their estate (their assets, property, investments, cash and valuable possessions) can potentially be subject to inheritance tax. Currently in the UK, the standard rate of inheritance tax on death is 40% and is only charged on the parts of the estate that are above the £325,000 threshold (known as the Nil Rate Band).
You don’t normally have to pay inheritance tax if:
- The estate’s value is below the £325,000 Nil Rate Band threshold.
- If everything in the estate is left to the deceased’s husband, wife or civil partner, a charity or community amateur sports club.
It is important to note that if you have made any large gifts in the 7 years before your death (exceeding your annual tax free giving allowances), then this could reduce the amount of Nil Rate Band your estate has available. If these gifts exceed your Nil Rate Band, then the recipients of the gifts may have to pay Inheritance Tax on them. After 7 years, these gifts would not be taken into consideration.
There is also an addition to the Nil Rate Band (known as the “residence Nil Rate Band”) which is currently set at £150,000 (and will rise to £175,000 in April 2020) when a residence owned by someone who has died is passed on to direct descendants (including adopted, foster and stepchildren). This means that you could potentially have up to £1million available free of tax by April 2020 if your estate is able to take advantage of this allowance. It is important to speak to a professional about whether or not this would be available to you, because there are certain criteria which need to be met for it to apply.
Reliefs and Exemptions
There are are a number of reliefs and exemptions from inheritance tax, including:
- If at least 10% of your net estate is left to charity, the tax rate is dropped to 36% on some assets.
- Some gifts made during the deceased’s lifetime will be subject to inheritance tax, unless the gift was made more than seven years before their death. In certain circumstances some gifts can still be taxable if made up to fourteen years before someone’s death.
- There is no limit for the value of gifts between spouses or civil partners, as long as they are both domiciled in the UK. There are specific rules and allowances if individuals are not UK domiciled.
- Business Property Relief allows certain business assets to be exempt from inheritance tax or be charged at a lower rate.
- Agricultural Property Relief allows certain estates that include a farm, to be exempt from inheritance tax or be charged at a lower rate.
- People whose jobs are considered dangerous (policemen, soldiers, paramedics, firefighters etc.) who die in certain circumstances whilst in service do not have to pay inheritance tax.
Who pays Inheritance Tax?
Payments are taken from funds from the deceased’s estate. This is arranged by the executor of the Will. Beneficiaries of a Will do not usually pay inheritance tax but may be subject to other taxes.
If you have received a large financial gift from someone during their lifetime which exceeds the Nil Rate Band they have available, there is a chance that the gift will be subject to tax and you as the recipient will need to pay, so please do get in touch if you think this may be the case.
If property is owned jointly and passes automatically to the surviving owner then the inheritance tax due on that property will normally be payable by the surviving joint owner.
Paying inheritance tax
Inheritance tax needs to be paid by the end of the sixth month after the person has died. If the bill isn’t paid by this time, HMRC will charge interest. Before payment is made, you will need to obtain a payment reference number from HMRC at least 3 weeks before you intend to make the payment. There are a number of ways to pay, including bank transfer, CHAPS or Bacs, at your bank or building society or via cheque.
In order to plan for inheritance tax and leave your loved ones as much as possible, there are a number of methods you can implement to legally limit the amount of tax you will have to pay.