Inheritance tax and how to reduce it

Inheritance tax is charged at 40% on the value of the deceased estate which exceeds the threshold, currently £325,000. If the deceased left his/her home to children or grandchildren in his/her will then the threshold can be increased using the main residence nil rate band – which is currently £100,000 – to £425,000.

For married couples or civil partnerships, any unused threshold can be added to the surviving spouse/partner to be available on their death (so their threshold can be as much as £850,000).

• give assets away which will reduce the estate's value on the date of death
• write a will which leaves assets to charity
• hold assets which obtain exceptions from inheritance tax
• take out life insurance. 

Assets can also be given away which will reduce the estate’s value on the date of death. Lifetime transfers of assets fall into three general categories: 

• transfers which are exempt from inheritance tax
• transfers which are potentially exempt transfers
• chargeable transfers, which are any other transfers of value.

(i)  Transfers of value between spouses or civil partners are exempt from inheritance tax. There is a restriction if the transferor is domiciled in the UK but the transferor’s spouse or civil partner is not so domiciled. This ‘domiciliary gift limit’ is £325,000.

(ii)  Annual exemption of £3,000

Transfers of value during the lifetime of a person up to a total of £3,000 per fiscal year are exempt from inheritance tax. If the gifts (if any) fall short of the above limit, the shortfall is carried forward to the following year and added to the allowance for that year. If the gift(s) exceed the limit, the excess must:

• if the gifts were made on different days, be attributed, so far as possible, to a later rather than an earlier transfer; and
• if the gifts were made on the same day, be attributed to them in proportion to the values transferred by them.

(iii)  Small gifts to same person (no more than £250)

Transfers of value during the lifetime of a person up to a total of £250 per fiscal year to any one person are exempt from inheritance tax. This exemption is in addition to the annual exemption of £3,000 referred to above. It applies to any number of gifts up to £250 to separate persons but cannot be used to cover part of a larger gift.

(iv)  Gifts in consideration of marriage or civil partnership

Gifts in consideration of any one marriage or civil partnership by any one transferor are exempt from inheritance tax on the value transferred without tax up to the following limits:

• £5,000 by a parent of either party to the marriage or civil partnership
• £2,500 by one party to the marriage or civil partnership to the other or by a grandparent or remoter ancestor
• £1,000 in any other case.

Any excess of gifts over the above limits is attributed in proportion to the values transferred.

(v)  Normal expenditure out of income

A transfer of value during lifetime is exempt if, or to the extent that, it is shown:

• that it was made as part of the normal (i.e. typical or habitual) expenditure of the transferor; and
• that (taking one year with another) it was made out of his income; and
• that, after allowing for all transfers of value forming part of his normal expenditure, the transferor was left with sufficient income to maintain his usual standard of living.

Gifts to charities are generally exempt from inheritance tax.

For deaths on or after 6 April 2012 inheritance tax is charged on the net chargeable value of an estate at a rate of 36% where 10% or more of that estate has been left to charity. These provisions will apply equally to charitable legacies made by will or by an instrument of variation.

Example

The estate of Henry who died on 31 July 2017 was valued at £440,000 comprising cash. He leaves a legacy of £15,000 to the Red Cross and the residue of £425,000 less inheritance tax passes to his children. The inheritance tax payable will be:

                                                                              £

Value of the estate                                      440,000

Less exempt gift to charity                            15,000

                                                                    425,000

Less nil band                                               325,000

Chargeable value of the estate                   100,000

As the gift to charity of £15,000 exceeds 10% of the net chargeable value of the estate, then inheritance tax payable will be £100,000 at 36% being £36,000.

The following assets qualify for business property relief:

(a)  Unincorporated business

(b)  Unquoted securities which either by themselves or with other such securities or unquoted shares gave the transferor control.

(c)  Any unquoted shares in a company not listed on a recognised stock exchange but including those traded in the USM or the AIM or Offex markets.

(d)  Shares or securities giving control of a ‘quoted’ company.

(e)  Land, buildings, machinery or plant held either

(i)    by a partner and used for the purposes of a business conducted by the partnership or

(ii)  by a controlling shareholder and used by that company for the purposes of its business or

(iii) by the trustees of a settlement and used for the purposes of a business carried on by a life tenant of the settlement.

Items (a), (b) and (c) above are eligible for 100% business property relief whereas items (d) and (e) above are eligible for 50% relief.

The following conditions need to be satisfied to obtain business property relief for the above assets:

(i)  the business, whether unincorporated or incorporated into a company in respect of the value of which relief is claimed, is a qualifying business; and

(ii)  the asset must be relevant business property and

(iii)  the asset must have been owned for a minimum period.

The property must have been owned by the transferor for a minimum period of two years immediately preceding the transfer; or

It replaced other property which qualified (apart from the two year period) immediately before the replacement and both properties together (or all properties if other qualifying property had been previously replaced directly or indirectly) were owned by the transferor for at least two years out of the five years immediately preceding the transfer.

This option does not reduce the amount of inheritance tax payable. However, it does mean that the insurance company will pay out cash on death of the person. That cash can then be used to pay the inheritance tax. Care should be taken to ensure that the insurance pay-out does not go to the estate which would make the estate bigger and therefore make the inheritance tax liability bigger.