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Inheritance tax can be a complex and confusing subject, but understanding the basics is essential to ensure that your loved ones are not left with a hefty tax bill after your passing. In this article, we will explore the guidelines surrounding inheritance tax in detail, including what it is, how it works, and how to plan for it.

What is Inheritance Tax?

Inheritance tax is a tax that is paid on the transfer of assets from the deceased to their beneficiaries. These assets can include money, property, and possessions.

Who Pays Inheritance Tax?

Inheritance tax is usually paid by the executor of the deceased’s estate. However, if the deceased has left a will, they may have specified who should pay the tax. If there is no will, the responsibility will fall to the person who is dealing with the deceased’s affairs.

When You Don’t Have to Pay Inheritance Tax

If the estate’s value is below the threshold, there is no Inheritance Tax to pay, but the estate’s value must still be reported. To determine whether the estate owes any tax, you need to estimate its total value, including the assets owned by the deceased on the day they died, any gifts they made in the seven years before their death, and the value of any trusts where the deceased had a beneficial interest.

If you are married or in a civil partnership and your estate is worth less than your threshold, any unused threshold can be added to your partner’s threshold when you die. The unused part of the threshold can be transferred to the surviving spouse or civil partner. If the unused threshold has not been fully used when the first partner in a marriage or civil partnership dies, the basic tax-free allowance available when a spouse or civil partner dies can be as much as £650,000.

In certain cases, such as when a home is passed on to a husband, wife, or civil partner, there is no Inheritance Tax to pay. If you leave your home to your children or grandchildren and your estate is worth less than £2 million, your tax-free threshold can increase to £500,000.

You can pay Inheritance Tax at a reduced rate of 36% on some assets if you leave 10% or more of the net value of the estate to charity in your will. Some gifts given while the person is alive may be taxed after their death, but taper relief might mean that the Inheritance Tax charged on the gift is less than 40%. Other reliefs, such as Business Relief, allow some assets to be passed on free of Inheritance Tax or with a reduced bill.

The executor, if there is a will, is responsible for paying the Inheritance Tax to HM Revenue and Customs (HMRC) using funds from the estate. Beneficiaries, the people who inherit the estate, do not usually pay tax on the inherited items. However, they may be subject to other taxes, such as rental income tax, if they inherit a property that generates rental income. People who receive gifts may have to pay Inheritance Tax if they are given more than £325,000 and the giver dies within seven years. 

Planning for Inheritance Tax

Planning for inheritance tax is essential to ensure that your loved ones are not left with a significant tax bill after your death. There are several steps that you can take to plan for inheritance tax, including:

  • Making a will: This ensures that your assets are distributed according to your wishes and can help to minimise inheritance tax.
  • Keeping records: Keeping records of your assets and how they are distributed can help your executor to calculate the inheritance tax due accurately.
  • Making gifts: Making gifts to your loved ones during your lifetime can help to reduce the value of your estate, thereby reducing the amount of inheritance tax payable.
  • Using trusts: Setting up a trust can help to minimise inheritance tax by removing assets from your estate.
  • Seeking professional advice: Consulting with a financial advisor or tax specialist can help you to understand your options and ensure that your estate is structured in the most tax-efficient way possible.

Make a Claim to Transfer Unused Basic Threshold

To make a claim to transfer unused basic threshold, you need to send a request to HMRC within two years of the death of the surviving spouse or civil partner. You can transfer any unused amount for deaths on or after 1 January 2022 and should claim when you apply for probate. If the person who died lived in Scotland, form C1 should be used. You can check which process to follow based on the type of estate and the date the person died. If you transfer less than the full unused threshold, you no longer qualify as an excepted estate, and a full return of estate with form IHT400 and form IHT402 must be made. Agricultural Relief can be applied if the estate includes a farm or woodland.

Inheritance Tax Passing on a House.

If you gift a home to a loved one and move out and live for another 7 years or longer, there usually isn’t any inheritance tax. However, if you decide to give the ownership of the house to someone else, and still opt to live in it, there are some things you must do.

  • You must ensure that you pay rent at the going rate of similar rental properties in the area.
  • Pay your share of bills.
  • Live there for at least 7 years.

If the above criteria aren’t met than the house will be classed as a ‘gift with reservation’, this is essentially when you give something away but continue to benefit from it.

A Gift with Reservation

You should also be aware that Inheritance Tax can be payable on gifts made during your lifetime, depending on the value of the gift and when it was made. Gifts made more than 7 years before your death are generally exempt from Inheritance Tax.

Gifts with reservation include:

  • Giving your home to a relative but still living there.
  • Giving away a caravan but still using it for free for your holidays.
  • Giving away a valuable painting but still displaying it in your house.

Gift tax and inheritance tax are closely related, as both are taxes on the transfer of assets. However, there are some key differences between the two:

  • Gift tax is payable on the transfer of assets during your lifetime, while inheritance tax is payable on the transfer of assets after your death.
  • The gift tax threshold is lower than the inheritance tax threshold, and the rates are different.
  • There are some exemptions and reliefs that apply to gift tax that do not apply to inheritance tax.

What is the 7 Year Rule?

From the previous section you may have noticed that 7 years plays an important number in determining the amount of inheritance tax that is required to be paid.

No tax is due on any gifts you give if you live for 7 years after giving them – unless the gift is part of a trust. This is known as the 7-year rule.

If you die within 7 years of giving a gift and there’s Inheritance Tax to pay on it, the amount of tax due after your death depends on when you gave it.

Gifts given 3 years or less before your death are taxed at 40%. After 3 years the amount of tax that you are required to pay differs.

Years Between Gift & Death Rate of Tax on the Gift
3 to 4 years 32%
4 to 5 years 24%
5 to 6 years 16%
6 to 7 years 8%
7 or more 0%

Different Reliefs and Inheritance Tax Exemptions Available

There are also a number of reliefs and exemptions available that can help reduce the amount of Inheritance Tax payable on an estate. For example, Business Relief can allow some assets to be passed on free of Inheritance Tax or with a reduced bill. Agricultural Relief may also be available if the estate includes a farm or woodland.

Who Pays the Tax to HMRC?

If Inheritance Tax is payable on an estate, it is usually the responsibility of the executor (the person responsible for administering the estate) to pay the tax to HM Revenue and Customs (HMRC) if there is a will. Beneficiaries (the people who inherit from the estate) do not normally have to pay tax on their inheritance.

Inheritance Tax on Property

Generally, there is no Inheritance Tax to be paid if either: (1) the value of the estate is below the threshold of £325,000 or (2) everything above the threshold of £325,000 is left to a spouse, civil partner, charity, or community amateur sports club. Even if the value of the estate is below the threshold, it may still be necessary to report the estate’s value.

it’s important to note that there are certain circumstances in which Inheritance Tax may still be due on a property, even if it is passed to a spouse or child. For example, if the property is worth more than the available tax-free threshold, or if the deceased made certain types of gifts or transfers during their lifetime.

It’s also worth considering the potential impact of other taxes, such as Capital Gains Tax, when passing on a property. Depending on the circumstances, there may be tax implications for both the giver and the receiver.

To ensure that your wishes are carried out as efficiently and effectively as possible, it’s a good idea to seek professional advice from our team of qualified experts at Town & Country. They can help you navigate the complexities of estate planning and ensure that your assets are distributed according to your wishes, while minimising the tax burden on your loved ones.

Working Out Your Estimate

To determine if the estate owes tax, you need to estimate the estate’s total value, including the assets owned by the person on the day they died, any gifts made within the 7 years before their death, and any trusts in which the person had a beneficial interest.

At this stage, the estimate only needs to be accurate enough to determine if the estate owes tax, and accurate valuations are required if the estate owes any tax. You can either estimate the value of the estate yourself or use the online Inheritance Tax checker, which provides an approximate value of the estate and helps you decide if any Inheritance Tax is likely to be due. However, the checker does not calculate the amount of Inheritance Tax owed or report the estate’s final value to HMRC.

Giving Your House Away Before You Die

If you give your home to your children or grandchildren, including adopted, foster, or stepchildren, your threshold can increase to £500,000. If you are married or in a civil partnership, and your estate is worth less than your threshold, any unused threshold can be added to your partner’s threshold upon your death.

What Is Unused Threshold?

When the first person in a marriage or civil partnership dies, any unused basic tax-free allowance, which is currently £325,000, can be transferred to the surviving spouse or civil partner. The basic tax-free allowance can be as much as £650,000 if none of the threshold was used when the first partner died. The unused percentage of the threshold that was not used when the first partner died increases the basic threshold available for the surviving partner’s estate. You can only transfer the threshold if you were married or in a civil partnership when the first death occurred and if you send a request to HMRC within 2 years of the death of the surviving spouse or civil partner.

Who Pays the Tax to HMRC?

The executor, if there is a will, pays the Inheritance Tax to HM Revenue and Customs using funds from the estate. The beneficiaries who inherit the estate do not usually pay tax on what they inherit. However, they may have to pay related taxes if they receive rental income from a house left to them in a will. The people who receive gifts may have to pay Inheritance Tax if the gifts exceed £325,000 and the giver dies within 7 years.

Tax if Someone Outside the UK Dies?

If you are domiciled abroad and you own UK assets, such as property or bank accounts, your estate may be liable for Inheritance Tax in the UK. However, certain assets are excluded from this tax, such as foreign currency accounts, overseas pensions, and holdings in authorised unit trusts and open-ended investment companies. To determine whether your assets are excluded, you can seek advice from Town & Country.

Double-Taxation Treaties

When a person dies and owns assets in multiple countries, there is a risk of double taxation, where both the UK and the country where the person was domiciled impose Inheritance Tax on the same assets. To avoid or mitigate this situation, the UK has established bilateral double tax conventions with many countries. These agreements can provide relief from double taxation by allowing for a credit or exemption for the taxes paid in the other country. Executors of an estate that may be affected by double taxation should consult a tax professional or the HMRC for guidance on the specific rules and procedures.

Conclusion

Inheritance tax can be a complex and confusing subject, but understanding the basics is essential to ensure that your loved ones are not left with a hefty tax bill after your passing. By following the guidelines outlined in this article, you can minimise the amount of inheritance tax payable and ensure that your estate is distributed according to your wishes. For help with this our skilled and professional team can help assist you and help to answer any questions you may have. Contact Town & Country Midlands now to get all the help you need!