What is Inheritance Tax

What is Inheritance Tax?

Inheritance tax is a tax on the estate (your assets) you leave behind when you die. The amount due to HMRC depends on the value of your estate and any allowances or exemptions that apply to your own set of circumstances.

Exemptions, Reliefs and Allowances

As with all taxes, there are various allowances, reliefs and exemptions that can be applied against any inheritance tax liability. The laws and rules in this area are complex and specific so it is worth taking advice on what may apply to you or your estate. Some common terms you may come across during your Estate Planning discussions are:

• The Spousal Exemption

If you are married and you leave your entire estate to your spouse when you die, this transfer is exempt of inheritance tax. This means that, if you are married and your spouse inherits your estate, there should not be any inheritance tax to pay on your death (although there are some exceptions to the rule).

• The Nil Rate Band Allowance

   

The Nil Rate Band is the sum that HMRC allows each individual person, on their death, before any inheritance tax is payable. At the moment (and for some years) this has been £325,000.00. This means that, a single person who has never married or is divorced and who has no children, has an allowance of £325,000.00. Their assets, which are over this value, will be (currently) taxed at 40%.

If you are married and you leave everything you have to your spouse, your spouse also inherits your Nil Rate Band. The transfer of assets to your spouse is exempt and on the death of your spouse, their Nil Rate Band will have doubled – they have their own Nil Rate Band of £325,000.00 and they have also inherited yours. The total Nil Rate Band which is allowed on the estate of the second of a married couple to die becomes £650,000.00. Everything over this amount is taxed at 40%.

The Residence Nil Rate Band

HMRC also provide for another allowance to be applied to estates of people who have children AND have or had a property contained in their estate when they die. This is called the Residence Nil Rate Band and is worth £175,000.00. This can be inherited by the surviving spouse in the same way that the Nil Rate Band above can be inherited. As long as, on the first death of a married couple who have at least one child, everything is inherited by the surviving spouse AND that spouse then leaves everything, including the property to their direct descents (child/grandchild etc), the total Residence Nil Rate Band is then doubled and is £350,000.00 on the second death.

The total Nil Rate Band for a married couple and the total Residence Nil Rate Band for a couple can be added together. If you are married, have a child or direct descendant and own a property, your total inheritance tax allowance on the second death will be £1,000,000.00. Everything over this will be taxed at 40%.

HOWEVER – note that the Residence Nil Rate Band was not introduced to help those who are considered to be especially wealthy. It comes with a ‘tapering restriction’.

The available RNRB is reduced by £1 for every £2 by which the deceased’s net estate exceeds the ‘taper threshold’ of £2 million.  It is possible that, depending on how large your estate is, that some of all of the Residence Nil Rate Band is lost and the inheritance tax that your, or your spouse’s estate pays, may be increased.

Gifts to Charities

Leaving gifts to charities in your Will can be an effective way of decreasing your inheritance tax liability and also benefiting a charity which is important to you.

Any gift that you make to a charity from your estate when you die is exempt of inheritance tax.

If you leave 10% or more of your estate (the assets that are held in your sole name and which are not in Trust and do not pass by survivorship) to charity, it may be possible to apply a lower rate of inheritance tax at 36% rather than 40% to the taxable part of the estate.

Business (Property) Relief & Agricultural Relief

Some business assets qualify for relief when it comes to inheritance tax. Whether or not it can be applied depends on the type of business, how many shares are held, the type of asset and how long the company has been owned for.

It is possible to invest in specific assets that qualify for business relief, which would be outside of your estate after being held for just two years, whilst you would still maintain control and have access to these assets. Following the 30 October 2024 budget, AIM shares’ BPR will reduce from 100% to 50% in April 2026, resulting in 20% IHT exposure.

You should take specialist advice to ensure you understand what may or may not be applicable to your estate.

Some estates will qualify for Agricultural relief but again, specific rules apply to its application, so you should take advice from an experienced professional.