Inheritance Tax (IHT) is understandably a touchy subject for many families and individuals. Once a person passes away who owns a large sum of estate, then that estate will be taxed by the government in order to redistribute back out to the state. Inheritance Tax can often be a very confusing topic of discussion, and also controversial, due to the fact that despite tax being paid by the deceased person throughout their life, the government still demands an additional tax on their property once they die.
How much tax is owed depends on the value of the deceased’s estate, which is calculated based on the deceased’s assets (i.e cash savings, investments, property, business, vehicles, life insurance pay-outs etc.), minus any debts accrued over time.
With thresholds increasing in line with inflation rates down the years, you can check out whether you need to pay IHT via the HMRC online portal, pending an estimate of your estate value.
What Is Inheritance Tax?
Modern IHT was first introduced in the UK in 1894, replacing several different Inheritance taxes, including the 1796 tax on estates introduced to help fund the war against Napoleon Bonaparte. The aim was to limit inherited wealth making the system fairer so the children of the rich don’t necessarily stay rich. Inheritance Tax redistributes income to the state for the benefit of all.
IHT is essentially a tax on your property, savings and other assets after any debts and funeral expenses have been deducted after you’ve deceased. Currently, the tax-free inheritance allowance is £325,000 which is also known as the nil-rate band. This threshold has remained the same since the 2010-2011 tax year and will remain at existing levels until April 2026 according to the Financial Act 2021. If the value of your estate exceeds £325,000, then the standard Inheritance Tax rate of 40% applies.
As well as the basic IHT allowance, since 2015 it is available to take advantage of the residence nil rate band, which is commonly known as the main residence band. This is an additional allowance on top of the IHT allowance of £325,000, if you pass on a main residence to your children or grandchildren.
The RNRB is available if a person owned their own property and their will or the intestacy rules (applied when there is no will) leaves their property to certain relatives defined as ‘lineal descendants’.
Are there ways around Inheritance Tax?
IHT can be reduced or avoided in a number of ways by complying with both tax-free allowances, by giving a certain amount of tax-free money away without it counting towards your estate. This can be done through a family member as well as married or civil partners in a legal manner, potentially saving large sums being given to HMRC once you’ve passed away. The surviving spouse is permitted to use both tax-free allowances, providing the deceased spouse did not exceed their full Inheritance Tax allowance through their will by with a large chunk of money. This basically means IHT can be avoided up to a £500,000 valuation of estate, should you choose to leave your estate to family members.
As well as this, when a spouse has died, assets left to the surviving spouse or registered civil partner, provided they’re living in the UK, are exempt from Inheritance Tax. This is because the partner’s Inheritance Tax allowance rises by the percentage of the allowance that isn’t used, meaning a couple combined can currently pass on a tac free sum of £1million (i.e £325,000 tax-free allowance x 2 + £175,000 main residence allowance x 2).
If a gift is given by the deceased person over seven years before their death, the ‘gift’ avoids Inheritance Tax. It’s worth noting however, any income made from the ‘gift’ for the beneficiary could be subject to other tax implications such as Capital Gains Tax.
Despite the ‘7-year’ rule that applies to gifts received before someone passes away, everyone is entitled to an exemption of £3000 a year. This means that you can give away £3000 a year without this amount being added to the value of your estate. This can also be rolled over, but only by one tax year.
The small gifts allowance allows you to give as many gifts as you like up to £250 per person each tax year. This allowance can not be combined with any other allowance so if you have already used the above £3000 allowance on an individual you can not then use the small gifts allowance on that individual
Gifts for weddings allows you to gift an amount towards an individuals marriage or civil partnership. The allowances are set as £5000 for a child, £2500 for grandchildren and £1000 for anyone else. This can be used in combination with the £3000 allowance effectively meaning that you £8000 you can gift to a child.
Who Does Inheritance Tax Affect?
Inheritance Tax technically affects anyone who has an estate worth over £325,000 (or £500,000 should the estate be passed down to children or grandchildren). Despite this, HMRC estimate only 1 in 20 estates in the UK pay IHT. If there the deceased person has a will, the person dealing with the contents of the will (the executor) arranges to pay the Inheritance Tax. In cases when a will hasn’t been created, the administrator of the estate carries this duty out.
IHT payments can be made from funds within the estate, or alternatively from funds obtained from the sale of assets. Most commonly, IHT is paid through the Direct Payment Scheme (DPS). This allows for the money in a bank or building society account of the person who has died to be paid in full, or in instalments, directly through the DPS by the person dealing with the estate.
Inheritance Tax must be paid by the end of the sixth month after the person’s death. If the timeframe is exceeded and tax hasn’t been paid, HMRC will start charging interest.
Why Is It Still Enforced By Government?
Inheritance Tax has been in force in the UK for over 120 years, with no signs that it will be abolished anytime soon.
HMRC raised £7.5 billion in IHT for the period from April 2023 to March 2024, the highest it’s ever been. It remains to be a significant contributor to the government’s tax revenue. That said, IHT is one area that is commonly know as a “discretionary tax” meaning if the correct planning is done using the appropriate exemptions and gifts then this could greatly reduce your potential IHT burden.
How Can Nordens help you?
Staying informed and proactive is key in the often-evolving tax environment that we find ourselves in. If navigating the obstacles of IHT feels overbearing, Nordens are here to help with all of your needs from your everyday accounting to Advisory, Tax, and more! With expert advice and tailored solutions, we ensure you’re always on the right side of tax regulations. Whatever you need guidance or assistance with, we have the knowledge and expertise to support you.
Contact us today at 0208 530 0720 or fill out our contact form to schedule a consultation.
