A Guide to Inheritance Tax

Introduction

After the death of a loved one, you need to work out if inheritance tax needs to be paid and/or if a full inheritance tax account is needed (HMRC form IHT400). According to Money Saving Expert, only around 4% of families have to pay inheritance tax, as most estates fall below the inheritance tax threshold.

When do you pay inheritance tax?

If their estate is valued equal to or less than £325,000, then there will likely be no inheritance tax payable. This is because everyone has a basic nil rate band amount (currently set at £325,000 and set to stay that way until 5 April 2028 - see here) available when they die, which they can pass on to their beneficiaries free from inheritance tax.

However, if their estate is valued over £325,000 there could be inheritance tax payable on the excess at a rate of 40% – but there are inheritance tax allowances, exemptions and reliefs that can help reduce, or negate, inheritance tax.

What are the different inheritance tax allowances and inheritance tax exemptions?

Depending on who inherits and the type of assets, there could be exemptions, additional allowances and reliefs applied to help reduce or negate inheritance tax.

The most common are as follows:

• Unlimited spousal exemption for UK domiciled spouses/civil partners
• Unlimited UK-based charity exemption
• Transferable nil rate band – if the person who has died has a spouse/civil partner that died before them, and the first spouse/civil partner to die has not fully used their own nil rate band then this can be claimed on top of their own. Effectively then doubling up the tax-free allowance from £325,000 to £650,000, if everything passed from the first spouse to the second spouse. Otherwise, if the first spouse to die has used some of their nil rate band, the proportion that has not been used can be claimed.
• Residence Nil Rate Band allowance – if there is a property which passes to direct descendants (ie children, grandchildren, stepchildren, fostered children, spouses of lineal descendants etc) then an additional tax free allowance of up to £175,000 is available, if they died on 6 April 2020 onwards - see here for thresholds over the years. And, in addition there could possibly be a transferable residence nil rate band allowance of up to £175,000, if there is a predeceased spouse/civil partner and they have not used it.
• Business Property Relief
• Agricultural Property Relief

As a tip: For both the transferable nil rate band and transferable residence nil rate band, these need to be claimed within 24 months from the date of death.

You may then need to pay inheritance tax and report the value of their estate to HMRC by providing a full inheritance tax account if the person who died:

• is single and their estate is worth more than £325,000 and there isn’t property passing to children or other direct descendants
• is single and their estate is worth more than £500,000 and there is property passing to children or other direct descendants
• is widowed and their estate is worth more than £650,000 and there isn’t property passing to children or other direct descendants
• is widowed and their estate is worth more than £1,000,000 and there is property passing to children or other direct descendants.

You can use the gov.uk online tool to check here.

How do I pay inheritance tax?

The first step is to build a picture of your dead loved one’s estate (their estate is everything owned by them) – you can find out more about this process, here.

You can use the gov.uk online tool to check if there is inheritance tax to pay or, if there is no inheritance tax to pay, whether a full account needs to be sent to HMRC here.

If there is inheritance tax to pay, you will need to firstly obtain an inheritance tax reference from HMRC here and complete form IHT400 to send to HMRC here.

When do you need to pay inheritance tax by?

If you need to report the value of the estate to HMRC, this has to be done within 12 months from the date of their death otherwise there will be penalties applied. And, if there is inheritance tax to pay, you should try and pay by the end of the sixth month after the person died to avoid interest, if possible. You can get more guidance on the government site by visiting: gov.uk/inheritance-tax

As a tip, you have to send the inheritance tax account to HMRC and pay, if not all the inheritance tax due, then at least the first instalment of inheritance tax (if the instalment option is available), before applying for probate. HMRC needs to send you a code, which is needed before you can prepare, sign and submit the application for probate.

Do I still need to do a full inheritance tax account even if no inheritance tax is due?

You may need to report the value of their estate to HMRC even if there is no inheritance tax to pay, if the estate does not fit into HMRC criteria of an ‘excepted estate’, where a full inheritance tax account would not be needed.

This is usually the case for deaths occurring on or after 1 January 2022 and if person who died’s gross estate (including non-exempt lifetime transfers):

• is over nil rate band £325,000 and they were single or divorced
• is worth £650,000 and there isn’t 100% transferable nil rate band available from the spouse or civil partner who died first living in UK
• is over 3 million and left everything to spouse or civil partner living in UK or to qualifying charity

Or they have:

• made non exempt lifetime gifts totalling over £250,000
• has foreign assets worth more than £100,000
• gave away an asset which they continued to retain a benefit from
• benefited from a trust which is worth over £250,000
• needs to claim residence nil rate band and the death occurred on or after 6 April 2017

To note, there are different set of rules for deaths prior to 1 Jan 2022.