When you pass away and leave assets to family or any other beneficiaries, they are liable for paying tax on those assets, known as Inheritance Tax (IHT). However, it is possible to significantly reduce the amount of IHT payable or, indeed, pay nothing at all depending on the value of any assets, known as your estate.
How much is inheritance tax?
How much IHT your beneficiaries pay largely depends on the value of your estate, or your assets which include any investments, life insurance policy payouts, property and even cash in the bank.
If the total value of your assets is less than £325,000, your beneficiaries will not be paying any inheritance tax. But if your assets value is above this threshold, they will pay 40% on the value of the assets above the threshold. For example, if your estate is valued at £500,000 and your threshold is £325,000, you will only pay IHT on the estate value above the threshold, i.e. £175,000.
However, there are exceptions to this basic rule.
- If you leave your entire estate that’s above the £325,000 threshold to your spouse or civil partner, charity or a community amateur sports club, your beneficiaries will not pay IHT.
- If you bequeath your home to your children, and this includes children that are fostered, adopted or stepchildren, the threshold may increase to £500,000.
- The IHT rate will drop to 36% on some of your assets if you choose to bequeath at least 10% of your estate’s net value to charity.
Inheritance tax for married couples
If you are in a civil partnership or are married the thresholds are different. If you die before your spouse:
- Assets left to your spouse/civil partner are exempt from IHT, if they are living in the UK.
- Any assets above the threshold are passed on to your spouse and added to their threshold, as well as their main residence allowance. So, potentially, your spouse’s/civil partner’s tax-free threshold level could be as much as £1 million.
Inheritance tax relief
There are various exemptions and tax reliefs that may apply to your estate, such as the nil rate band (NRB), taper relief and business property relief.
- Residence nil rate band (RNRB) – any part of the estate that is over the nil rate band (NRB) – every person’s threshold of £325,000 – that is passed on to the spouse/civil partner, as well as any gifts, can be passed to the surviving spouse/civil partner and is exempt from IHT. In April 2017, the residence nil rate band was introduced and is an additional amount to the NRB, which can be transferred.
- Taper relief – it is applicable when inheritance tax is due to be paid on a ‘gift’ that was granted 7 years prior to your death. Essentially, any gifts passed on before your death are subject to IHT but the longer it is since you made the gift prior to your death, the amount of tax your beneficiary has to pay is based on a sliding scale, i.e. it is tapered. For example, a gift made 3 years before your death is liable to 40% tax. Gifts made 7 years before you died are tax-free unless they are part of a trust. Known as the 7-year rule, you must keep a record of what you gave, how much it is, when you gave it and who you gave it to, and your executors must know these details as well. However, a ‘gift with a reservation’, i.e. the gift is still in use by you, is considered part of your estate.
- Business property relief – business property tax relief can reduce the amount of IHT paid on any business assets, such as shares, buildings or any business machinery. If you own a business, or are a partner in a business, it forms part of your estate on your death and your beneficiaries will be liable for tax on that asset. However, it is possible to reduce the amount of tax paid by claiming business relief by 50%, or even 100%. For example, if you are a sole trader and bequeath your business to family that’s valued at £400,000, the £325,000 threshold applies and is eligible for business property relief on the remaining £75,000; therefore, zero tax is paid. However, if you only owned 50% shares in the business, i.e. voting rights, or 50% shares in an unlimited company, i.e. 50% of the land, buildings and/or equipment/machinery, only 50% business relief is claimable.
How do gifts work in terms of inheritance tax?
There are some ‘gifts’ you can make prior to your death which will reduce the level of inheritance tax payable and, in some cases, mean no tax is paid. A gift includes:
- Personal items, such as jewellery or antiques.
- Household items, such as furniture.
- Property, including a house, buildings or land.
- Stocks and shares, as listed on the London Stock Exchange.
- Unlisted shares, i.e. shares in an unlimited company, if you have held them for less than 2 years prior to your death.
- Money; this also includes money that remains should you sell a gift for less than it is worth. For example, if you sell your property to a spouse or child for less than the market value, the monetary difference is considered a gift.
Gifts do not include any assets you leave to beneficiaries in your will. Those assets, such as cash in the bank, possessions and any other property, are considered part of your estate and are valued accordingly for inheritance tax purposes.
Any gifts to your spouse/civil partner during your lifetime are exempt from inheritance tax as long as you are legally married or in a civil partnership, and they permanently live in the UK. In addition, any gifts to political parties or charities, if they are before your death, are exempt from IHT.
Every person is allowed to give away up to £3,000 worth of gifts in any tax year and they won’t be added to their estate, and therefore be liable for IHT. Known as an ‘annual exemption’, you can gift £3,000 to one person or distribute the amount between different people. You are also allowed to carry it forward to the next tax year, but only for a single year.
This inheritance tax exempt rule also applies to annual birthday or Christmas gifts, up to the value of £250, as well as gifts towards a wedding or civil partnership ceremony.
At Probates Online, we are able to offer a professional probate service online that is efficient and affordable. If you are an executor of a will and need to apply for a Grant of Probate or would like to take advantage of our entire Estate Administration service, visit our website for more information or contact us today.