Inheritance tax in the UK is payable at a rate of 40%. It is applied where the value of a person’s estate exceeds the tax-free threshold, which is currently set at £325,000.
Inheritance tax liability can however be reduced through careful planning. Making a will and full use of exemptions, reliefs and other tax planning tools such as gifts and trusts can help to legitimately lower inheritance tax liability and the amount that will be taken from your estate before it is passed on to your heirs.
Inheritance tax rates & thresholds
When an individual dies, any belongings that they leave behind is collectively known as their estate. The estate could include:
- personal possessions
- shares and investments
- insurance policies
- gifts made within the seven years before death
To determine if inheritance tax will apply, take the total value of the deceased’s estate and deduct any financial liabilities, such as a mortgage or funeral costs. If this figure is £325,000 or less, it falls under the nil rate band and will not be subject to inheritance tax. Anything over this amount is taxable at 40%.
Using inheritance tax exemptions and reliefs can help to bring down the amount that is subject to tax.
How to reduce inheritance tax through exemptions & reliefs
The following exemptions and reliefs should be considered when calculating inheritance tax liability:
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.
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. This means the estate of the surviving partner has a tax-free threshold of £650,000.
Residence nil rate band
As of April 2017, you can pay less inheritance tax if you are leaving property to a family member. For the 2020-21 tax year, the transferable allowance is £175,000.
This nil rate band relates to the residential property of the deceased and only applies to deaths since 6 April 2017.
Under the 2020/21 rate, the first £175,000 of the value of the deceased’s home will be exempt from inheritance tax should the property be inherited by a direct descendant.
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.
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
Under Agricultural property, individuals can pass on agricultural property free from inheritance tax. 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.
The property can be passed on either during the owner’s lifetime or as part of their will.
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 farmhouse 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%.
Are gifts taxable?
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
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, but only for one 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 to any other person within any tax year, provided no other exemption has been used on the same person by the person gifting.
Inheritance tax & trusts
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.
Inheritance tax – key takeaway
It is always advised that when drawing up a will, you should investigate all available options that may offer a reduction in inheritance tax, and that you continue to keep up to date with any changes in inheritance tax legislation which may impact your estate and your wishes being carried out.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.