What is Inheritance Tax?
Not everyone pays Inheritance Tax (IHT). It's only due if your estate (including any assets held in trust and gifts made within seven years of death) is valued over the current IHT threshold - £325,000 until April 2015. The tax is payable at 40% on the amount over this threshold.
Nil-Rate BandInheritance Tax is commonly known as a ’death duty’. It was originally designed as a means to break up disproportionately large estates, as a response to the growing power of the landowners. However, in its current form it is often criticised for hitting the ever-growing middle classes the hardest. Currently, IHT is levied at a rate of 40% on estates which exceed a certain threshold, known as the Nil-Rate Band and until April 2015 that threshold is set at £325,000.
Although this may seem like a considerable sum, the rise in the value of property in the last 10 years has made this an ever-more relevant concern for a large number of people. It is perfectly possible (and, indeed, in many parts of the country it is highly probable) that the value of your house alone exceeds this sum. As a result, IHT may well affect you and those who will inherit your estate.
Increased Threshold for Married Couples and Civil PartnersMarried couples and registered civil partners are allowed to pass assets during their lifetime or when they die without having to pay IHT – no matter how much they pass on, provided the person receiving the asset has their permanent home in the UK.
Since October 2007, married couples and registered civil partners can effectively increase the threshold of their estate when the second partner dies to as much as £650,000 in 2013-2014. This is known as spouse or civil partner exemption.
If someone leaves everything they own to their surviving spouse or civil partner, it's not only exempt from IHT but it also means they haven't used any of their own IHT threshold or nil-rate band. It is therefore available to increase the IHT nil-rate band of the second spouse or civil partner when they die, even if the second spouse has remarried. Their estate can be worth up to £650,000 in 2013-2014 before they owe IHT.
To transfer the unused threshold, the executors or personal representatives of the second spouse or civil partner to die, need to send certain forms to the HM Revenue & Customs (HMRC). HMRC calls this 'transferring the nil-rate band' from one partner to another.
Exceptions to the RuleThere are currently two exceptions to this rule: if, for example, the estate of the first spouse or civil partner had qualified for relief on woodlands or heritage property; or if the surviving spouse or civil partner had an Unsecured Pension as the 'relevant dependant' of a person who died with an Alternatively Secured Pension. The rules are complicated and are available in full from the Probate and Inheritance Tax Helpline details of which are available on the HMRC website.
However, this does not extend to co-habiting unmarried couples, or to the children of married couples or those in a civil partnership.
In order to combat the financial difficulties that can be posed in the latter of these two cases, it may be advisable to investigate the possibility of establishing discretionary trusts. This can also help in the case of unmarried co-habitees, as assets which are placed in trust are essentially separated from the remainder of the estate, thus reducing the individual’s total taxable assets.
Inheritance Tax Exemptions and ReliefsOther than to your spouse or civil partner, sometimes, even if your estate is over the threshold, you can pass on assets without having to pay IHT. These include any gifts you make to a 'qualifying' charity during your lifetime or in your will. You can make small gifts of up to £250 to as many individuals as you like, and if you survive for seven years after making a gift to someone, the gift is generally exempt from IHT, no matter what the value. A full list of exemptions and reliefs can be found on the HMRC website, if in doubt seek professional advice.
For more information on Inheritance Tax, read our article Top Tips For Cutting Your Inheritance Tax Liability and Choosing Inheritance Tax Planning Advice on this site.