A quick guide to inheritance tax

Inheritance tax is a complex area, often shrouded in misconceptions. In this article, Lorraine Wilson sets out the basics and answers key questions about inheritance tax.

What is inheritance tax?

Inheritance tax in the UK is a tax charge on the estate of someone who has died. The current rate of inheritance tax is 40%.

There are also instances where inheritance tax is payable during a person’s lifetime (for example, on the creation of a trust). Inheritance tax also applies to trustees.

Who pays inheritance tax?

Generally speaking, inheritance tax on death is payable from the estate of the person who has died. It is the responsibility of the executors/personal representatives to ensure that the tax is calculated, paid and appropriate clearance is obtained from HM Revenue and Customs.

However, there are some instances where inheritance tax might be payable by a beneficiary. In particular, the recipient of a lifetime gift may be liable to pay inheritance tax on the sum received if the person making the gift dies within seven years.

There are also occasions where trustees (or the beneficiary of a trust) are liable pay inheritance tax.

When do you have to pay inheritance tax?

Inheritance tax is payable 6 months following the month in which death occurs. HMRC will charge interest on any inheritance tax which remains unpaid after 6 months.

Probate cannot be granted until the inheritance tax has been paid. UK banks and building societies will usually agree to pay inheritance tax directly to HMRC from the deceased person’s account with appropriate authority from the executors assuming that there is sufficient money available.

The requirement to pay ‘up-front’ can lead to cash-flow difficulties for executors where non-cash assets cannot usually be accessed without probate.

In certain circumstances (for example, where the estate assets are tied up in property or in a business) the executors of an estate can opt to pay the inheritance tax in instalments over a period of up to 10 years. However, strict criteria apply to the instalment option and interest will continue to accrue throughout the entire period. The instalment option comes to an end immediately once an estate asset is sold.

What is the threshold for inheritance tax?

Every UK-domiciled individual has an inheritance tax allowance, known as the “nil rate band”, available to their estate. The nil rate band is currently £325,000 (and is set to remain at this level until at least April 2026). The nil rate band can be ‘used’ during a person’s lifetime by making lifetime gifts, so careful planning and professional advice is recommended.

In addition to the nil rate band, certain individuals will benefit from an additional allowance known as the “residence nil rate band” of up to £175,000 per person. However, strict criteria apply and not everyone will qualify for this additional allowance. Professional advice should be sought.

Spouses and civil partners can transfer their unused Nil rate band allowances to each other. A married couple who meet all of the relevant criteria could potentially have up to £1million in allowances between then before any inheritance tax is payable.

The value of a person’s estate above the nil rate band is subject to inheritance tax at a rate of 40%.

Are there any exemptions?

There are a number of possible exemptions and reliefs from inheritance tax which can significantly reduce the amount of tax payable. Some of the most common exemptions and reliefs are:

• Spouse/civil partner exemption — anything left to a legally registered spouse or civil partner is exempt from inheritance tax (but note that a “common law spouse” does not qualify).
• Charity exemption — anything left to a UK or EU registered charity is exempt from inheritance tax.
• Reduced rate of tax — Tax may be charged at 36% instead of 40% if a minimum of 10% of the estate is left to charity;
• Business relief — Reduces the value of a business when calculating how much inheritance tax has to be paid. Only trading businesses can qualify for relief and strict criteria apply. Business relief is available at 100% or 50% depending on the nature of the business assets.
• Agricultural relief — applies to qualifying agricultural property so that it can be passed on with an appropriate deduction representing of the value of the assets actually used for agricultural purposes. Strict criteria apply. Agricultural Relief at 100% or 50% depending on the owner’s use of the property for agricultural purposes.

In addition, various exemptions and reliefs can apply to lifetime gifts, such as the “annual exemption” of £3,000 per year and “normal expenditure out of income”.

Keep in mind that exemptions and reliefs can change. Taking legal advice from a professional will ensure that you can claim any appropriate relief and pay the correct amount of tax.

At Weightmans, our team of experts can help you to navigate the inheritance tax rules, whether as part of your estate planning or if you are acting as the executor of an estate.