What is Inheritance Tax?

Aside from the dreaded income tax, Inheritance Tax (also known as IHT) is perhaps the form of revenue for the Exchequer that elicits the most vitriolic response from the general population. It has become something of a rallying call for certain disgruntled groups, but many people are still in the dark as to its details.

Nil-Rate Band

IHT is what is 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. Currently that threshold is set at £285,000, but this is reconsidered annually in order to keep it pegged roughly to inflationary rises. £285,000 may seem like a considerable sum, but the seemingly unstoppable rise in the value of property 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, Inheritance Tax may well affect you and those who will inherit your estate.

Exceptions

There are a number of circumstances in which Inheritance Tax may not apply. The most widely relevant of these is the exception for spouses. If you are married or are in a civil partnership, then any assets which pass to your spouse or civil partner will not have IHT levied upon them, regardless of their value. This means that there is no risk, for example, of the surviving partner being forced out of their home as a result of their inability to pay the taxman. However, this exception 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, which combine the Nil-Rate Bands of both partners in order to maximise the tax efficiency of the estate. 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.

There are also certain assets which are not counted towards the total taxable estate; these include personal effects, but this definition can sometimes be vague. Similarly, there are certain circumstances in which an ‘excepted estate’ might exist for reasons other than that of its value (which must be measured at the market value at the time of death by the executor of the deceased individual’s will or, if they died intestate, by an appointed administrator); this can occur in cases, for example, where the deceased was not resident in the United Kingdom. The rules regarding excepted estates are relatively complex, and are available in full from the government’s DirectGov website or your local tax office.