Inheritance Tax (IHT) is 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.
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.
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 and Are There Ways Around It?
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. For the tax year of 2021-2022, 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.
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).
Moreover, a gift which is defined by something given to someone without any reservation, no nods, winks or mutual backscratching (e.g wedding presents, sums of money, land, property) could be exempt from IHT. If the gift is given by the deceased person over seven years before their death, this means the ‘gift’ avoids IHT. 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.
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.
IHT 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 Inheritance Tax 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. In 2008, IHT brought in almost £4billion annually as property prices soared pre-financial crash. Once the economic downturn happened, measures were introduced that allowed couples and civil partners to share their tax allowances meaning IHT decreased to £2.4billion in 2010.
Saying this, the government recently announced that it is no longer required to fill in Inheritance Tax forms should HMRC recognise the estate of a deceased person doesn’t exceed the thresholds set out.
In the Tax Day document released by the government on 23rd March 2021 it states the update to tax reforms ‘will also cut inheritance tax red tape for more than 200,000 estates every year, dramatically reducing the amount of paperwork many families fill out. Over 90 percent of non-tax paying states each year will no longer have to complete inheritance tax forms when probate or confirmation is required from 1st January 2022. None of the tax day announcements will have any impact on the government’s finances or require legislation in the current Finance Bill.’
How Can I Comply With Inheritance Tax Regulations?
Inheritance Tax information and regulations can be found via the dedicated government portal IHT page. As stated in this article, there are numerous ways to reduce, and even avoid, your Inheritance Tax bill legally and by the book.
Should you wish to further discuss the ways to do this and your potential options concerning IHT, or anything accounting related for that matter, please don’t hesitate to get in contact with us at Nordens where one of our trusted advisors would be happy talking you through your query.