When an individual dies, any belongings that they leave behind, collectively known as their estate, become subject to inheritance tax. Their estate could include:
- personal possessions
- shares and investments
An individual’s estate could also include money or other assets that they have gifted and upon which inheritance tax is chargeable under the following conditions:
- gifts made by the deceased individual within the seven years before their death
- gifts made by the deceased where they benefitted in some way from the gift and that benefit was still current at the time of their death
- certain gifts made during their lifetime, such as transfers of cash or assets into a trust
Inheritance tax may also come into play in the case of a trust arrangement where the beneficiary does not have absolute rights over the trust-held assets or any resulting income. In this case, the trustees would become liable to pay inheritance tax.
A trust is required to make a tax payment at a corresponding rate on the tenth anniversary of the setting up of the trust, the decennial charge. A further tax payment is made where any assets are sold or otherwise leave the trust, and should the trust be closed. Both payments are referred to as exit charges. Neither of these charges are connected with inheritance tax.
What exemptions and reliefs may be applied to a deceased person’s estate?
The executors of a deceased estate are responsible for paying inheritance tax at a rate of 40% of the estate value. When calculating whether there is an inheritance tax liability, the executors should take into account the following factors:
- the value of the estate, including any gifts made within the seven years before death, that amounts to more than the nil rate band
- transferable nil rate band
- residence nil rate band
- other applicable reliefs or exemptions
The current inheritance tax nil rate band is £325,000. This means that if the deceased estate is valued at more than £325,000, there is an inheritance tax liability.
Transferable nil rate band
Where the deceased is survived by their spouse or civil partner, the value of any portion of the deceased’s nil rate band that is not used may be transferred to the surviving partner’s nil rate band.
Residence nil rate band
This nil rate band relates to the residential property of the deceased and only applies to deaths that have occurred since 6 April 2017.
The first £100,000 of the value of the deceased’s home will be exempt from inheritance tax should the property be inherited by a direct descendant.
It is planned to increase the value of the residence nil rate band by £25,000 each tax year. This means that by the 2020/21 tax year, this relief will stand at £175,000.
There are however, certain conditions:
- The property in question must have been used by the deceased as their home for a period of time.
- Other properties that the deceased owned at the time of their death will not be eligible for this relief.
- Where the deceased had more than one residence, ie. more than one property that they lived in as a home, only one of those properties will be eligible.
- The residential property in question must be left to a direct descendant, such as a child, grandchild, stepchild, adopted child, foster child, or spouse.
- Where the deceased estate is worth more than £2 million, there will be a reduction made to the residence nil rate band of £1 for every £2 in excess.
Should a surviving spouse or civil partner receive any assets from the deceased estate by will, joint ownership, or other disposition, these assets will not be chargeable for the purposes of inheritance tax.
Business property relief
The taxable value of any business assets that form part of the deceased estate may be reduced where business property relief is applicable. Assets that are eligible for this form of relief include:
- a business or an interest in that business – rate of relief 100%
- unquoted securities and unquoted shares amounting to control of an unquoted company – rate of relief 100%
- unquoted shares listed on the Alternative Investment Market – rate of relief 100%
- quoted shares which amount to control of a company – rate of relief 50%
- land, property, machinery and plant, used by a company or partnership – 50%
- land, property, machinery and plant, used by a beneficiary’s business – 50%
Eligibility for business property relief relies on the fact that the deceased owned the asset, or business, for a minimum of 2 years before their death.
The following are not eligible for business property relief:
- businesses dealing mainly in securities, land or property
- businesses who make or hold investments
- not-for-profit organisations
Where the business is being sold, this form of relief is not available unless the new owner of the business will carry it on and payment to the estate is made largely of company shares.
Equally, business property relief is not available where the business is closed down, except for specific corporate reorganisations.
Agricultural property relief
This type of relief is available on some agricultural property in the UK, the Isle of Man, the Channel Islands, or in European Economic Area countries.
Eligible agricultural property includes land or pasture used for the following:
- growing crops
- rearing animals
- stud farms
- the planting and harvesting of trees
- unfarmed land under the Habitat Scheme
- unfarmed land under a crop rotation scheme
- land associated with the value of milk quota
- farm property (cottage, house or other building) appropriate to the farming activity
- certain agricultural securities and shares
Agricultural property relief does not cover farm equipment and machinery, derelict buildings, livestock, harvested crops or any property linked to a binding sales contract.
This relief is applied to the ‘agricultural value’, that is, the value of property whose sole purpose is agricultural. Where a farmhouse, for instance, is worth more than the agricultural value, no relief will be available on the excess value.
For a farm house or cottage to be eligible for relief, it must be the residence of:
- an individual involved in farming
- a retired farm worker
- or the spouse or civil partner of a deceased farm worker
Further eligibility rests on the condition that they be a tenant under an employment related contract or a protected tenant with statutory rights of residence.
Any property must have been owned by the deceased and occupied by them for the purpose of agriculture for at least two years before their death. This two year condition also applies where the property was occupied by a company whom the deceased controlled or by the spouse or civil partner of the deceased. Where anyone else occupied the property instead, this two year period stretches to seven years.
The value that is eligible for relief does not include any mortgage on the property or debts secured against it.
The Agricultural Property Relief rate is 100% in any of the following circumstances:
- The property owner farmed it in hand.
- The property was rented to a third party on a short term grazing licence.
- The property was subject to a tenancy dating from 1 September 1995 or later.
- The deceased owned the property before 10 March 1981 and it was rented before that date, the property was eligible for relief under the old estate duty rules, and the deceased had no right to vacant possession between 10 March 1981 and their death.
Where none of the above apply, the Agricultural Property Relief rate is 50%.
The connection between inheritance tax and gifts
Often people forget to take gifts into account when considering inheritance tax, so how exactly could making a gift impact on inheritance tax liability?
Potentially exempt transfers
Should the person making a gift live for seven years afterwards, that gift becomes exempt from inheritance tax.
Any gift made into a trust is generally seen as a chargeable lifetime transfer, however, there may be no inheritance tax liability where assets transferred into a trust in a seven year period are of less value than the nil rate band or other reliefs are applicable.
The annual exemption allows gifts to be made up to a value of £3,000 per year without incurring inheritance tax. Unused annual exemption may be carried forward to the following year.
Wedding or civil ceremony gifts
Wedding or civil ceremony gifts may be made each year without incurring inheritance tax up to the following amounts:
- for your child, up to £5,000
- for your grandchild or great-grandchild, up to £2,500
- in all other cases, up to £1,000
Gifts to political parties and charities
This category of gift incurs no inheritance tax.
Normal expenditure from income
Where your income amounts to more than your usual expenditure, it may be possible to gift all or part of the remaining amount without incurring inheritance tax under the following conditions:
- the gifts are a regular part of the donor’s expenditure, and
- the gifts are from the donor’s income, and
- the donor is left with sufficient income to maintain their current lifestyle
Gifts up to a value of £250
There is no limit on the number of gifts up to the value of £250 that a person may make in any tax year.
When planning ahead for the possibility of inheritance tax, a life assurance policy may go some way towards helping with this. However, this will depend on personal circumstances and the specific policy.
Deed of Variation
It may be possible to change the terms of a will within two years of a death, where all beneficiaries are in agreement. This Deed of Variation, usually drawn up in the form of an election, may prove effective in reducing inheritance tax liability.
Inheritance tax – final word
It is always advised that once you have drawn up a will, you investigate all available paths that may lead to a reduction in inheritance tax for your heirs, and that you continue to keep up to date with any changes in inheritance tax legislation which may impact your estate.