Inheritance Tax Explained

Inheritance Tax can sometimes be unclear. Nicola Briggs explains how it works below.

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By Nicola Briggs - 30th July 2021

If a deceased person’s estate is over a certain threshold, inheritance tax will be charged. The standard rate is 40%.

Inheritance tax is a tax on taxed income. You go to work and pay your taxes and with what is left you start to build your pot for the future. If you don't spend it all during your lifetime and instead leave some for your family, that money will be taxed again. The HMRC get a good opportunity to look through your affairs when you die, as a tax account has to be submitted in order to obtain a Grant of Representation. The HMRC will then determine if inheritance tax is payable.

Calculating the value of an estate

Inheritance tax is payable on the value of the estate as it was immediately before death. That is why the people administering a deceased person’s estate (called the personal representatives) must calculate the exact value of the deceased’s assets and debts at the date of death. The HMRC will take a dim view of those who have made up figures or have been reckless with the truth. The HMRC have the right to charge penalties in such cases.

This is a significant undertaking for the personal representatives, especially as some assets that fall within the estate are not readily apparent. These might include:

  • A half share of a jointly owned asset where that asset has passed immediately on death to the co-owner; and
  • The value of gifts made within seven years prior to death; and
  • All life interests the deceased held such as a right to occupy a property or receive income from a fund.

This can be difficult information to collate where you do not know the deceased that well.

Once the value of the estate is established, you can deduct one or two nil rate bands and one or two residence nil rate bands depending on the facts of the case.

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Nil rate band

The current basic nil rate band is £325,000 and it has been that since 6 April 2009. It is likely to remain at this level until at least 2026. By not increasing this figure, more and more people are becoming liable to pay inheritance tax.

Before 9 October 2007, a spouse had one allowance and the other spouse had their own allowance. Since 9 October 2007, it is possible to transfer these allowances between married couples and civil partners. Where the first to die did not use up their £325,000 because they only had, say, £100,000 in their estate, the other £225,000 of allowance can be added to the £325,000 of the second to die. Potentially the second to die can have a nil rate band totalling £650,000.

Residence nil rate band

Another tier of complexity was added on 6 April 2017 when the residence nil rate band came into force. If an individual has up to £175,000 of equity in a home in which they have lived which they are passing on to lineal descendants, they can have an extra allowance to that amount. For example, where the house is only worth £100,000, that is all the residence nil rate band can be. Where the house is worth £500,000, the residence nil rate band can never exceed £175,000. As with the transferable nil rate band, the residence nil rate band is also transferable between spouses and civil partners.

The net effect is that a married couple or a civil partnership with equity in a house of £350,000 can leave £1million free of inheritance tax. Anything over that will be taxed at 40%.

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Get professional advice

This is a rather simplistic overview of the unduly complex inheritance tax legislation. For this reason, we recommend that you get professional advice, if you are currently administering a deceased person’s estate.

We also recommend that you take steps to mitigate your inheritance tax bill during your lifetime. This might include ensuring that any mortgages on the residence are moved to other property so as to increase the equity in the home to take it up to £350,000. For those with valuable estates, lifetime gifting can minimise the effect of the tapering of the residence nil rate band, as those with an estate over £2million cannot fully benefit from it. There is a reduction of the allowance pro rata to the extent that the estate exceeds £2 million.

Inheritance tax: cohabiting vs marriage

Inheritance tax is unkind to those who live together and who are not married or in a civil partnership as each member of the relationship will only have an individual person’s allowances and that applies when they make gifts to one another. In a marriage or civil partnership, there is no inheritance tax between spouse or civil partner, so there are substantial financial benefits to getting hitched.

At Aticus Law, we take into account the tax implications for you when discussing your Will.  This is an integral part of the Will-making process, so an initial discussion of its impact is included within our fee. Should complex tax planning be required, we are on hand to provide that advice additionally.

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