Inheritance tax – not just a death tax!

Most people think of inheritance tax as something that will be due on their estate on death – so it may come as a surprise to learn that inheritance tax can be due during your lifetime!

Generally speaking, inheritance tax is due when someone makes a transfer of value. To determine how much tax is due, the following steps are required:

  1. Identify that a transfer of value has been made. This might happen on death but equally can happen if you give away property during your lifetime – whether the gift is made directly, or into a trust. For some transfers during your lifetime, the inheritance will be due at the time the gift is made. For others, the tax will only be due if you die within 7 years of making the gift.
  2. Identify the value transferred. For lifetime gifts, the value is the ‘loss to your estate’. Whilst often this will mean the value of the actual property transferred, it may not always be the case.
  3. Consider any exemptions or reliefs that may be available. There are a range of exemptions and reliefs to consider for both lifetime gifts and gifts made on death.
  4. Identify the relevant rate of tax. This will depend on whether any of your ‘nil rate band’ (i.e. inheritance tax allowance) is available, and whether you are making the gift during your lifetime or on death. In some cases if you die between 3 and 7 years of making the gift, a reduced rate of tax may be payable.

Everyone gets a basic ‘nil rate band’ or inheritance tax allowance of £325,000. On top of that, married couples and civil partners can claim the unused percentage of their deceased partner’s inheritance tax allowance, at current rates. Any transfer to husband/wife/civil partner is free of inheritance tax (the ‘spouse exemption’) so for example, if a husband dies leaving everything to his wife, 100% of his inheritance tax allowance is unused and a 100% uplift can be claimed by the wife’s Executors on her death.

A fairly recent additional allowance – the resident nil rate band (RNRB) – has further extended what can be passed on free from inheritance tax. Whilst the general inheritance tax allowance of £325,000 is to remain the  same until at least April 2021 (Finance (No 2) Act 2015, s 10), the RNRB (inserted into the IHTA 1984 by ss 8D–8M) gives those dying on or after 6 April 2017 an extra threshold where the family home is passed on to lineal descendants. The allowance is:

  • £100,000 – in force now (since April 2018)
  • £125,000 – from April 2019
  • £150,000 – from April 2020
  • £175,000 – from April 2021.

Where an estate is valued at £2 million+ the RNRB is reduced by £1 for every £2 over the £2 million threshold.

Any unused percentage of the RNRB can also be claimed on the second death by the Deceased’s estate. Note that, as for claiming an uplift in the ordinary nil rate band, it is a percentage uplift. So, if A dies when the RNRB is £100,000 and doesn’t use any of the allowance, B gets 100% uplift – even if the RNRB has increased to £175,000 before her death.

In short, this means that a couple can potentially leave their children up to £1 million free from inheritance tax by 2021. Whilst this should satisfy the majority of estates in England and Wales, it means some inheritance tax will still be payable for others. It is therefore essential to have a good understanding of the wide range of exemptions and reliefs available, and the possibility of lifetime giving to reduce IHT on death.

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