Inheritance tax (IHT) is a complex subject. This article takes a simplified approach to the topic and aims to provide useful information that will help executors of a will and administrators of an estate understand this aspect of the probate process. While it doesn’t cover all eventualities and isn’t a ‘deep dive’ into IHT, it will answer a lot of questions and, for simple estates, it should tell you all that you need to know.
What is Inheritance Tax?
Inheritance Tax arises in respect of a deceased individual’s estate when they die (i.e. a tax on their property, money, and possessions). It is typically charged at 40% on the value of the estate above the available tax-free thresholds, such as the Nil Rate Band (NRB) and the Residence Nil Rate Band (RNRB).
However, the tax burden can be reduced or eliminated through exemptions and reliefs. Understanding IHT is essential for executors and personal representatives of an estate to ensure compliance with tax laws and to make the most of available allowances, while also managing any tax liabilities that may arise during probate.
What is Nil Rate Band (NRB) for Inheritance Tax?
Every individual on their death has what’s called a ‘nil rate band’ (NRB). This is currently £325,000. What this means is that the first £325,000 of their estate is taxed at 0%.
For married couples and civil partners, any unused portion of the deceased’s spouse’s NRB can also be added to the NRB of the surviving spouse. This means on the second spouse’s death, their estate could have a NRB allowance of up to £650,000 before any inheritance tax is payable.
Inheritance Tax on Gifts
This NRB can be reduced if an individual made certain lifetime gifts during the seven years prior to their death. You are allowed to give away up to £3,000 per financial year without those gifts reducing your NRB.
Additionally, you can give as many gifts of up to £250 to as many people as you like, as long as they haven’t already received part of your £3,000 annual exemption. You may also give wedding gifts without impacting your NRB: up to £5,000 to a child, £2,500 to a grandchild, or £1,000 to any other friend or relative.
How does the Residence Nil Rate Band (RNRB) affect Inheritance Tax?
The residence nil rate band (RNRB) is an additional sum of £175,000 that can be claimed if the person who has died passes on their family home to direct descendants (children or grandchildren). As with the NRB, married couples and civil partners can pass their unused RNRB to the second to die such that, on the second death, the estate benefits from an additional £350,000 taxed at 0%, bringing the combined NRB and RNRB total up to £1,000,000.
However, the benefit of the RNRB tapers away if an estate’s net value is worth over £2,000,000. This is at a withdrawal rate of £1 for every £2 value more than £2m. If your estate is worth over £2,350,000 at the time of death, the RNRB will be extinguished. Also, note that the £350,000 available on the second death can only be claimed against the property. So, if the property in question is valued at £250,000, you can only claim £250,000 for the RNRB even if up to £350,000 is available.
Inheritance Tax Rates Explained
As can be seen from the above sections on the NRB and RNRB, inheritance tax is charged at 0% where the NRB and RNRB apply. Other than in circumstances where there are exemptions to IHT (see below), tax is payable at 40%.
However, if the estate is leaving more than 10% of its net value to registered charity or charities, the rate of tax falls to 36%. Calculating the value of the net estate can be complex and legal advice may be needed.
How to Reduce Tax Liabilities with Inheritance Tax Exemptions
Spousal Exemption from Inheritance Tax
Any money or property passing to a surviving spouse or civil partner is exempt from inheritance tax. As a result, any amount of property or money can pass this way without attracting any liability to pay IHT.
How Charitable Donations Affect Inheritance Tax
Any money or property left to a registered charity in a will is completely exempt from Inheritance Tax (IHT). Additionally, as noted above, if 10% or more of the estate’s net value is given to charity, the overall IHT rate on the remaining estate decreases from 40% to 36%, offering further tax benefits.
Inheritance Tax Reliefs for Businesses and Farms
Claiming Business Property Relief (BPR) for Inheritance Tax
Business Property Relief (BPR) can also reduce Inheritance Tax on certain business assets by either 50% or 100%, depending on how the business is structured and the type of assets involved. To qualify, the business assets must have been owned for at least two years before the owner’s death. BPR can apply to assets passed on through a will or given as lifetime gifts. This relief typically covers shares in qualifying businesses, land, buildings, or machinery used for business purposes, offering significant tax savings for business owners and their heirs. BPR is not available for a business or a partnership that is wholly or mainly an investing business.
Agricultural Property Relief (APR) for Inheritance Tax Explained
Agricultural Property Relief (APR) is a relief for inheritance tax which is available to farmers and landowners on transfer of agricultural property, provided that certain conditions are met. To qualify, the property must have been used for agricultural purposes, such as farming, by the owner or their spouse for at least two years before the owner’s death if they farmed it themselves, or seven years if it was rented out. While farm machinery does not qualify for APR, it may still be eligible for Business Property Relief (BPR) if it’s used as part of a farming business.
How to Pay Inheritance Tax and Avoid Penalties
If IHT is due on an estate, it must be paid within 6 months of the end of the month of death. For example, if someone dies on 12th January, IHT is payable by 31st July.
Even though IHT must be paid in full by this date, you can request to pay by instalments on the family home. Paying by instalments means that the sum due on the property is split into ten payments, the first being due at the date identified above. Interest will accrue on any unpaid IHT at 2.5% above base and 4% on instalments. HMRC may also levy a fine for late payment of IHT.
It is possible for executors and personal representatives to appeal the penalties, if they are able to provide a reasonable excuse or special circumstances of their failure to pay tax on time but ignorance of the law is not classified as a reasonable excuse.
Contact a Specialist Probate Solicitor
Executors and administrators of estates are often understandably anxious about Inheritance Tax, how to calculate it, when it’s due, penalties for lateness and unpaid IHT accruing interest. The overview set out above should help understand the primary issues and alert executors and administrators to the key dates and issues involved. However, there are many complexities hiding behind some of the above topics which are outside of the scope of this article.
If you are an executor or administrator of an estate and have questions about Inheritance Tax, or on any issues relating to probate, please do not hesitate to contact one of our specialist Probate Solicitors or get in touch on 020 8492 2290.
