Inheritance tax is payable on the “taxable estate” that an individual leaves behind when they pass away. The taxable estate is made up of the following:
- all the assets that the deceased owned
- the share of any assets that were jointly owned
- the share of any assets that pass automatically by survivorship
Any liabilities or debts that might be due should be subtracted from the value of the estate.
Inheritance tax is payable at 40% on any amount over a threshold of £325,000. For example, if a taxable estate is worth £425,000, inheritance tax would need to be paid on the extra £100,000. This equates to a payment of £40,000.
However, if the deceased left 10% or more of their estate to charity, this rate is cut to 36%. Inheritance tax will generally be paid from the estate itself unless the Will specifies that one of the beneficiaries should pay the inheritance tax instead. To calculate the amount of inheritance tax due, you will need to count the total value of the estate, in terms of money, shares, trusts, property, and any other assets. You must also include gifts that the deceased made in the seven years preceding their death, and any payout from a life insurance policy or a lump sum payable on death from a pension.
However, any debts can be subtracted from the estate, as can any funeral or probate costs which were paid for out of their estate.
There are a number of confusing exceptions that can crop up in the valuation of an estate, so you should get help from a solicitor if you are concerned that you may make a mistake. If you decide to do it yourself, you should retain all the paperwork you used to reach your final valuation.
Before you can pay inheritance tax, you will need to contact HMRC to request an Inheritance Tax Reference. You can do this on their website, or by downloading and posting form IH422. This reference should take between 2-3 weeks to arrive. Once you have the reference, you should fill in and return form IHT400.
Inheritance tax is generally due six months from the month that the deceased passed away. If this much time had passed before you paid, you will have to pay interest. However, you can choose to pay inheritance tax in instalments over the course of ten years on assets which may take time to sell, such as a house or business.
Inheritance Tax Exemptions
Certain types of gifts that can be left in a will are exempt from Inheritance Tax. No IHT is payable on gifts to the following beneficiaries:
- husband, wife or civil partner
- charities and certain national institutions like museums and universities
- political parties (who must have a certain level of representation and support)
Some gifts given during your lifetime are also exempt from inheritance tax.
- Gifts of up to £3,000 pounds can be given away each year which will not be subject to inheritance tax when you die. These are very useful for bringing the value of your estate below the £325,000 threshold when you die.
- You can give £250 per year to as many people as you wish, but this cannot be to the recipient of your annual £3,000 gift. This is useful for people with large families or a lot of grandchildren.
- Wedding or civil partnership ceremony gifts are also exempt. Parents can give up to £5,000, grandparents £2,500 and anyone else £1,000. The caveat is that the gift must be given or at least promised shortly before or on the day of the ceremony.
- You are allowed to make regular gifts with your regular surplus income, albeit not using your capital. These may include monthly payments to someone or regular gifts for special occasions such as birthdays and wedding anniversaries.
Other Tax Issues for Beneficiaries
Being named as a beneficiary in a Will – meaning you will be inheriting property, possessions or a sum of money – can have certain implications with regard to the tax you have to pay.
Being named as a beneficiary can affect your tax liability. Your situation with respect to income tax depends on whether you receive a specific gift, the residue or income from the residue of the estate.
Specific gifts can be money or an asset that you receive from the deceased’s Will. You will not usually have any income tax liability unless it’s an asset that produces income or your legacy was paid late and your Personal Representative pays you interest on it.
It is the responsibility of the Personal Representative to work out the residuary income of the estate for each year that it is being administered. A share of that income may be paid to the beneficiaries during the administration or after the period of administration has concluded. If you receive a payment during the administration it will be considered as income for the tax year.
Be aware however that this income received from the residue may make you liable for income tax at a higher band or may cause you to pay more tax if you receive an age-related allowance. If either of these is the case, you should inform the HRMC.
These changes in income will affect your income tax so whenever you get a payment from your Personal Representative make sure that you ask them for a written statement using form R185. This form will show you how much tax is treated as having been paid on income and how much income to write on your tax return for that year.
Capital Gains Tax
This tax applies when the Personal Representative decides to sell capital assets from the estate. It also applies when someone inherits assets from the deceased’s estate and then decides to sell or dispose of the property. In this case, the person will have to deduce the capital gain or loss.
The chargeable gain is when an asset is sold, disposed of, given away or exchanged and its value has increased since it was acquired. The Capital Gains Tax is the charge on the increase of its value in the time period it was owned, not the asset itself.
When the Personal Representative takes control of the assets of the deceased, it is considered that they gained control of them at the market value at the date of the deceased’s death. However, when an asset is inherited to a beneficiary through a will or intestacy, it does not fall under Capital Gains Tax.
If the Personal Representative needs to sell assets from the estate to settle debts, pay Inheritance tax or give cash to beneficiaries, they will have to declare any chargeable gains you realise on estate assets. This will be paid out of estate funds. Capital Gains Tax is applicable on capital gains on estate assets during the administration and is charged at a rate of 28%.
When you take control of the deceased’s assets, they are treated as if you had acquired them at their market value at the date of death.
When you transfer an asset to a beneficiary under the will or under the rules of intestacy, you are not treated as disposing of it for Capital Gains Tax purposes. You have no chargeable gain or allowable loss on that disposal. Instead, the beneficiary is treated as if they had acquired the asset on the date of death, at its market value on that date.
Sometimes you may need to sell assets during your period as Personal Representative, for example, to raise money to pay Inheritance Tax or to settle cash legacies. If so, you will have to declare any chargeable gains you realise on estate assets, and pay Capital Gains Tax out of estate funds. Capital Gains Tax is chargeable on the personal representative only on gains arising on estate assets during the period of administration.