Inheritance Tax is basically a tax on wealth when it is passed on depending on various circumstances, being chargeable on the global assets of individuals domiciled in the United Kingdom and on the United Kingdom assets of non-domiciled individuals.
Domicile is a complex issue and it is different from nationality or residence. A person can have one domicile only at any one time. They are domiciled in the country which is their permanent home, basically the country where they come from and in which they intend to live later on in life.
The amounts of Inheritance Tax
When someone dies, the value of their estate above a certain amount, usually the nil rate band, is liable to Inheritance Tax. Currently, the nil rate band is £325,000 and the rate of tax is 40%. Some gifts which they make during their lifetime can also be liable to Inheritance Tax immediately, or potentially liable later on.
If the value of a person’s estate exceeds £325,000, Inheritance Tax is charged at 40% on the excess. If they give a legacy of at least 10% of their estate to charity, the rate would be reduced to 36%. However, it would be necessary to ensure that the charity gets the amount that is intended; wills need to be worded carefully.
Definition of estate
The value of a person’s estate comprises all their residential properties, investment properties, contents and personal effects, cash, cars, monies on deposit including in ISA accounts, stocks and shares, certain insurance policies.
There are various exemptions available and, with careful planning, Inheritance Tax can be reduced further as will be mentioned below.
An individual can make various gifts during their lifetime which are either completely exempt from Inheritance Tax, or potentially exempt.
The completely exempt gifts are as follows:
- Gifts of any amounts to exempt beneficiaries or “donees”, for example to a husband, wife or civil partner who has a permanent home in the United Kingdom, to a qualifying charity, some national institutions such a museums, or to a UK political party. There is a restriction on transfers from a UK domiciled person to their non-UK domiciled spouse or civil partner. From 6th April 2013, transfers of up to the nil rate band only, which is currently £325,000 are exempt; prior to that date the limit was £55,000.
- Gifts worth up to £3,000 in total per tax year.
- Wedding or civil partnership ceremony gifts; £5,000 by each parent, £2,500 by each grandparent or great grandparent, £2,500 by the groom to the bride and vice versa, and £1,000 by anyone else.
- Small gifts up to the value of £250 to as many individuals per tax year.
- Regular gifts or payments that are part of the normal expenditure. This means regular gifts such as birthday presents and maintenance payments made out of after-tax income, but not from capital.
Potentially exempt transfers
A potentially exempt transfer is any gift made to an individual as long as the donor lives for seven years after making the gift. This must be an outright gift where the donor does not keep an interest in it. If the donor dies within seven years after making the gift, it would become chargeable to Inheritance Tax. If the death occurs between three and seven years after making the gift, and the total value of gifts made are above the nil rate band threshold mentioned above, any Inheritance Tax due would be reduced on a sliding scale.
Gifts which are not either completely exempt or potentially exempt will utilise a person’s nil rate band. Therefore, it is imperative to take reasonable care not to waste the nil rate band as, once it has been used up, Inheritance Tax could be chargeable on further transfers.
Business property and agricultural reliefs
Subject to the qualifying conditions, certain assets can be passed on free of Inheritance Tax, or at a reduced rate, while a person is still alive or through their will. Those assets include the following:
- business assets, for example shares in a private company, a building or equipment used in the business;
- agricultural property, for example a working farmhouse;
- woodland timber; and
- National heritage property, and famous and important works of art.
The creation of a trust can be an effective way of reducing Inheritance Tax. Although, gifts into a trust are chargeable lifetime transfers, if the gift can be kept below the nil rate band, it would not normally be taxable. Furthermore, the gift would not be included in the donor’s estate if they survive seven years after making the gift.
When planning for Inheritance Tax, a person needs to take a long-term view of their own situation, particularly their future financial needs.