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Understanding the latest inheritance tax updates

Inheritance tax (IHT) is currently under long overdue scrutiny by the Office of Tax Simplification. So what will they have to untangle after years of growing complexity?

How much is IHT?

The basic rate of IHT is 40%. When gifts are made more than three but less than seven years before death can the rate be lower, thanks to “taper relief”, but this is not as generous as it appears.

Trusts have their own IHT regime, involving a 20% entry charge, 6% charges every 10 years, and exit charges at a fraction of 6%. Again, the details of the rules can be hard to fathom.

Are there any reliefs?

The following are normally free of IHT, but “the devil is in the detail”:

  • Most gifts made more than seven years before death
  • The “nil rate band”, which is the first £325,000 of an estate (but see below)
  • Gifts between married couples and civil partners
  • Gifts to UK charities
  • Certain small and regular lifetime gifts (see below)
  • Some business and agricultural assets.

The transferable nil rate band

On the death of a widow or widower, the £325,000 nil rate band is increased to up to double, or £650,000, to the extent that their late spouse did not make full use of their own allowance.

Small lifetime gifts

Everyone has a £3,000 annual exemption each tax year. This can be carried forward to the next year if it is not used.

All gifts of £250 or less to any other individual are exempt, as long as the same person has not received any part of the £3,000.

There are special exemptions for gifts to those getting married.

Regular gifts from income

Regular gifts from surplus taxable income are free of IHT. The donor must be able to maintain their usual standard of living without resorting to capital. The gifts must be regular, for example of the same amount, or deriving from the same source, or all intended for a specific purpose. Provided these conditions are met, there is no limit on the size of regular gifts from surplus income which can be completely free of IHT.

Then there are two recently introduced allowances:

  • The residence nil rate band - This now adds an extra £125,000 to the £325,000 nil rate band, is due to increase again in the next two years to reach £175,000 from 6 April 2020, and is doubled for a widow or widower whose spouse has not used their allowance. It is available for those whose home is of at least the value of the allowance, and provided the home passes to their descendants. The relief is extraordinarily complex and not everyone who thinks there is now a £1 million IHT allowance for a married couple will qualify
  • Charitable gifts on death - If at least 10 per cent of what would otherwise be taxable is given to charity, the rate of IHT reduces from 40% to 36%.

There are also some more obscure reliefs for:

  • Maintenance of one’s own family - For example, a parent’s payment of school fees for his children is not an IHT event. This is straightforward, and parents are using it all the time without thinking of it as an IHT event
  • Heritage property - Where land, buildings, works of art or other assets are of sufficient importance, relief is conditional on certain undertakings about preserving them. But the assets must be of outstanding artistic or historical importance, so this relief is rare
  • Growing timber - Tax is deferred until the timber is sold, but this is rarely an advantage as IHT ultimately has to be paid on the sale proceeds.

Anthony Nixon, tax partner at Irwin Mitchell Private Wealth, says: “Inheritance tax, with all its exemptions and obscure reliefs, grows increasingly complicated and is in desperate need for reform. It’s good that the Office for Tax Simplification is looking into this matter but it’ll be years before any tangible change is made. Families in today’s society need change now rather than later.”

Find out more about inheritance tax

Published: 24 July 2018

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July 2018

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Anthony Nixon