Inheritance Tax: What is it and how is it charged?

Inheritance Tax (IHT) is a form of UK tax that becomes payable on the estate of someone who has died, including all property, possessions and money. When is IHT charged? IHT is primarily a charge on your assets on death, including your share of any assets held jointly with another person. However, lifetime gifts of more than £3,000 in each tax year (unless they fall into an excluded category) made within the last seven years prior to your death can also be brought back into your estate to be calculated for IHT purposes. IHT is also charged where an asset appears to have been given away, but where you, in fact, retain the use of (or a significant benefit in) the asset given. For example, where you give your home (in which you continue to live) to your children and do not pay them the full market rent for your occupation. This is referred to as a ‘gift with reservation of benefit’. IHT is also charged on lifetime gifts to companies and to certain types of trust (called "relevant property" trusts) and these trusts also suffer periodic IHT charges. The word "gift" is used in this article for ease of explanation; however, it is important to bear in mind that the law governing IHT is complex and covers scenarios that might not be immediately recognised as a gift, for example, selling assets at an undervalue between certain family members, or your company, trust or partnership. Therefore, if you sell a house worth £100,000 to your son or daughter for £10,000, you have effectively made a gift to them of £90,000. IHT can also cover the use of property and fixed-term interest-free loans. Although IHT is a charge on individuals, you cannot seek to avoid it by using a company which you control to make gifts on your behalf. What is the Nil-Rate Band? The Nil-Rate Band (also often referred to as the IHT threshold) is the threshold above which an individual’s estate is liable to pay IHT. The current Nil-Rate Band is set at £325,000 and is frozen until at least April 2021. Each individual has a Nil-Rate Band and, since 6 April 2017, individuals may also qualify for an additional Nil-Rate Band, known as the Residence Nil-Rate Band (up to £175,000), if you leave your family home to direct lineal descendants (e.g. children, grandchildren etc.). If you are married or in a civil partnership, any unused basic Nil-Rate Band or Residence Nil-Rate Band can be transferred to the surviving spouse or civil partner on their death. For example, if you were to leave all of your estate to your spouse/civil partner, an exemption known as spousal exemption applies (regardless of the value of your estate) and your estate will not be subject to IHT, nor will you use up any of your available Nil-Rate Bands. On the death of the surviving spouse/civil partner, their Personal Representatives can transfer your unused basic Nil-Rate Band (maximum £325,000) and any unused Residence Nil-Rate Band (maximum £175,000) for them to use in addition to your surviving spouse/civil partner’s own available Nil-Rate Bands. I will consider both exempt and non-exempt beneficiaries and the Residence Nil-Rate Band in more detail in future articles. What is the rate of tax? The Nil-Rate Band is charged at 0%, meaning that the first £325,000 (potentially £500,000 if the Residence Nil-Rate Band applies) of your estate is not taxed, provided you have not made any lifetime gifts which has reduced your Nil-Rate Band. Once you have deducted the Nil-Rate Band from the total value of your assets, the balance is then charged at the following rates:

• 20% for lifetime gifts to companies or to relevant property trusts (with further tax due if the donor dies within seven years of making the gift).

• 40% on estates on death.

If you leave 10% or more of your net estate to charity on your death, the rate of IHT which applies is reduced from 40% to 36%. Where lifetime gifts are brought back into charge (because they were made in the seven years before death), any IHT payable on these gifts may be reduced. The longer you survive from the date of the gift, the less IHT is payable, provided you survive for at least three years. Relevant property trusts have their own IHT regime, which can see IHT charged at a maximum rate of 6% every ten years and also when capital is distributed to beneficiaries. There are, however, various exclusions, exemptions and reliefs which can be applied or claimed to reduce the amount of IHT payable and these will be discussed in a future article. It is, therefore, important that you regularly review the value of your estate and seek professional advice in relation to estate planning, including reviewing the terms of your Will, to ensure your estate is as tax efficient as possible. If you require any advice or assistance concerning IHT, please do not hesitate to contact me at liam@bmd-law.uk where I will be happy to discuss your requirements.