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INHERITANCE TAX (IHT) - Coggle Diagram
INHERITANCE TAX (IHT)
LIABILITY AND BURDEN
- LCT - during lifetime
Person in whom the assets vest (donee) is usually liable to pay IHT = trustees of the trust which receives the assets + Payment is made using the settled assetsIf trustees do not pay tax > donor becomes liable / donor may elect to pay the tax
- If donor pays IHT using their own funds their loss is effectively assets settled + IHT liability
- Failed PETs + LCTs that become chargeable to IHT following the donor’s death
lifetime recipient (donee) is liable to pay the IHT due within12 months from end of the month of death
-IF NOT > deceased’s PRs will become liable so should retain sufficient funds to pay the tax bill should the need arise
Taxable Death Estateassets that are excluded from their succession estate > succession estate assets pass to PRs to be administered under the will/intestacy rules “free estate”Death - free estate
- IHT on the free estate is a general testamentary and administration expense
- PRs are liable to pay this tax > IHT is paid from residue unless a contrary intention appears in the will
- Free estate - contrary intention: gifts within a will are paid subject to a deduction of the IHT attributable to them / testator could direct that the residue bears the burden of IHT due in respect of assets outside of the free estate
- Variations to the rule do not (and cannot) remove or reduce the overall liability
Death – other items
- taxable assets that fall outside of the succession / free-estate
- these items bear the burden of the IHT attributable to them + liability for payment falls on the beneficiary of the item:
- Joint tenant property: surviving co-owner
- Statutory nomination: snominated beneficiary
- Donationes mortis causa: lifetime donee
- Trust assets: trustees
- GROB: lifetime donee
EXEMPTIONS AND RELIEFS
LIFETIME ONLY
- Annual Exemption
allows individuals to make gifts of up to £3,000 each tax year free from IHT + should be used after any other available exemptionOnce the AE for current tax year is used first + in full a transferor may look back to previous tax year (but no further) + use any part of the AE not used at the time = maximum of 2 x AE (£6,000)
- Family maintenance
Maintenance payments are not treated as transfers for IHT purposes if made to:
- spouse (or former spouse if part of a divorce settlement) >used is spousal exemption does not apply
- minor child of either party to a marriage for maintenance, education or training, or if over 18 and otherwise in full time education or training
- dependent relative to make reasonable provision for their care
- Small gifts allowance
- Small gifts (of up to £250 per recipient) can also be made free from tax > transferor can make multiple gifts of up to £250 to as many different people as they like
- small gifts allowance is not available if combined with any other exemption, including the AE
- Marriage Exemption
A gift given in consideration of a marriage to a party of that marriage is exempt up to:
- £5,000 if made by a parent of one of the parties
- £2,500 if made by one party of the marriage to the other
- £2,500 if made by their remoter ancestor e.g. grandparent or great-grandparent; and
- £1,000 in any other case
The relief applies per donor + marriage exemption and the annual exemption can both be claimed in respect of the same gift
- Normal expenditure out of income
A transfer of value is exempt if made:
- from the donor’s income (not capital)
- as part of a normal/regular pattern of giving, and
- do not affect the donor’s standard of living
There is no upper limit to this exemption > HMRC are more likely to accept the relief applies if transfers are made under a legal obligation
Taper ReliefTaper relief is not an exemption > reduces the amount of IHT that would otherwise be payable - to apply:
- lifetime transfer was made 3 – 7 years prior to the transferor's death + IHT is payable in respect of the lifetime transfer
So transferor must have died + value of the lifetime transfer must have been large enough to trigger IHT Although taper relief is only applied after someone has died, the relief has no effect on the IHT payable in respect of their death estate.
LIFETIME & DEATH
- Spouse exemption
Gifts between spouses domiciled within the UK during life and following death are completely exempt > no upper limitA gift may be conditional provided the condition is satisfied within 12 months of deathOn a person's death, spouse exemption will apply to the value of assets transferred to a life interest trust if the surviving spouse receives a life interest BUT NOT IF they receive a remainder interest
- Charity exemption
All transfers to registered charities in UK / EU during life + following death exempt irrespective of amount given provided the gift is used exclusively for the purposes of the charity + must be immediate and not in remainder for the exemption to apply
- gift can be conditional provided the condition is satisfied within 12 months
Reduced rate of IHT (36% instead of 40%) may be available in respect of the chargeable assets in the estate IF deceased leaves at least 10% of their estate to charity
- Political party exemption
- Gifts to established political parties are exempt from IHT > party had at least two MPs elected + party had at least one MP elected and at least 150,000 votes given to candidates representing that party
- Exemptions for gifts for national purposes or to heritage maintenance funds
- Gifts are exempt from IHT where they are made for designated ‘national purposes’ = museums and galleries which exist for specified purposes
- gifts to funds which are designated as ‘heritage maintenance funds’ are exempt from IHT = trusts which maintain historic buildings or land of scenic, scientific and historic interest + fund itself not required to pay IHT
- Exemption for gifts to EBTs
- exemption for transfers of shares made into Employee Benefit Trusts
- Exemption for gifts to housing associations or to a registered social landlord
Business Property Relief - LEARN FROM BLPAgricultural Property Relief
Reduces IHT payable on agricultural value of qualifying assets
- Qualifying agricultural property: Agricultural land and buildings used for purposes connected with agricultural activity / Farmhouses and cottages if associated agricultural land and have been occupied for the purposes of agriculture
- Qualifying periods of ownership: occupied for agricultural purposes by the transferor throughout the 2 years immediately before the transfer OR owned by the transferor and occupied by them or another for agricultural purposes throughout 7 years immediately before the transfer
- Rates of relief: 100% relief is available if the transferor was the owner occupier OR 50% relief applies less frequently, and usually in respect of tenancies created before September 1995
Exceptions which also apply to BPR:
- qualifying assets are sold and replaced with new qualifying assets within a certain period of time, the taxpayer’s period of ownership is usually treated as continuous
- person inherits qualifying assets following someone’s death, they are deemed to acquire the assets on the date of death
- person inherits qualifying assets following the death of their spouse, they are deemed to have owned the property from when it was originally acquired by the deceased spouse irrespective of how long they were married
APR and lifetime transfers
- IF taxpayer makes a PET or LCT of qualifying agricultural property + transfer is assessed to IHT following the death of the transferor within 7 years, APR is only available for the lifetime transfer if the qualifying property transferred: is owned by the transferee + qualifies for APR when the transferor dies + no minimum ownership requirement of 2 years for the transferee
Interaction of APR and BPR
- APR is given in priority to BPR in scenarios where both reliefs would apply
- It is not possible to claim BPR on a business asset if that asset also qualifies for APR
- Agricultural buildings may qualify for both – so APR applies in priority
- Livestock is not included in the definition of agricultural property but its value may qualify for BPR
- Farmhouses/cottages are unlikely to qualify for BPR, but may qualify for APR
DEATH ESTATE ONLY
- Woodlands relief
Gifts of woodland following death may qualify for woodlands relief:
- If deceased purchased woodland + owned it for at least 5 years before dying for the relief to apply
- If deceased inherited woodland following someone else’s death > no qualifying period of ownership
Deferral of the IHT that would otherwise be payable on the value of the woodland = value of the woodland is the value of the trees (i.e. timber) and not the land itself
- To use the deferral those administering the estate should make an election to exclude the value of the woodland from the death estate.
may be preferable to consider alternative reliefs that might apply instead:
- BPR should be considered where woodland is used for commercial purposes
- APR can be considered if the land is classified as agricultural land
- BPR and APR are more generous reliefs and if they apply would usually be claimed instead of woodland relief
- Quick succession relief
QSR intended to help the tax-payer where same assets would otherwise be subject to more than one IHT charge in quick succession.QSR applies where a person dies and:
- their death estate includes assets received by way of gift or inheritance + in the 5 years before their death + those assets were subject to an IHT charge when transferred to the deceased
For QSR to be relevant IHT must have been payable – both on the original transfer and following the subsequent death > tax paid previously is credited against the later IHT chargeIf death occurs with one year of the previous IHT charge, the relief is calculated with reference to 100% of the amount of IHT paid previously
- This reduces each year, and only 20% of the amount of IHT paid previously is considered where death occurs 4-5 years after the original charge
NIL RATE BANDS
Basic nil rate band is £325,000 = first £325,000 of a transfer subject to IHT is taxed at 0%
Individual’s surviving spouse / civil partner can inherit unused portion of their basic NRB = ‘transferable nil rate band’ (‘TNRB’)
- TNRB is only available after the surviving spouse dies > Individuals who have survived more than one spouse can claim the TNRB in respect of all of them, subject to a cap of 100% of a full nil rate band + have to make separate claims for each
- Individuals entitled to claim a TNRB with regards a previous marriage/civil partnership can also pass this on to any subsequent spouse they have
TNRB: Making a claim
- PRs of surviving spouse must make a claim for TNRB in the IHT return within 2 years of the end of the month of death OR within 3 months of PRs first acting, if this is later
- If NOT, anyone else who is liable to pay IHT on surviving spouse’s death can make the claim after the deadline for the PRs to claim has passed.
Residence nil rate band (‘RNRB’)Applies if: deceased died on or after 6 April 2017 + death estate included a ‘qualifying residential interest’ (‘QRI’) + QRI was ‘closely inherited’ by a ‘direct descendent’
- If part of the QRI is closely inherited but other is not = only chargeable value closely inherited is taken into account when calculating the value of the RNRB
Amount
- full RNRB is £175,000
- If deceased’s share / interest in property is less than £175,000 = RNRB amount is capped at the value of the property
- Tapered withdrawal of RNRB for estates with a net value of more than £2 million > IF survivor’s estate could claim £350,000 RNRB this amount is reduced by £1 for every £2 in excess of £2m, and no RNRB can be claimed for net estates worth £2,700,000 or more
Qualifying residential interest (QRI) = residential property interest which is part of the deceased’s estate immediately before death > interest in a dwelling-house which deceased occupied as their residence at some point during their period of ownership
- includes property in which the deceased did not live but intended to do so in in due course NOT include rental investment properties in which the deceased never lived
- IF deceased had more than 1 residential property interest in estate at death > must nominate one of them as their QRI
Closely inherited = beneficiary closely inherits from the deceased if they receive the QRI by:
- gift under the will - specific legacy of deceased’s home / taking a whole or part share of the residue which includes such property
- operation of the law of intestacy
- operation of the rules of survivorship
- beneficiary with a contingent interest following death does not ‘closely inherit’ for these purposes as they are not receiving an absolute interest
Direct descendants:
- deceased’s children, grandchildren, great-grandchildren and other lineal descendants
- adopted children, step-children, foster children and children for whom the deceased was a guardian or special guardian are included
- Spouse or civil partner of anyone included in 1)
- Widow, widower or surviving civil partner of anyone included in 1) who has pre-deceased the deceased, provided the survivor does not re-marry or enter a new civil partnership before the deceased dies
- NOT siblings, parents, nieces, nephews
Transferring unused RNRBPossible to transfer any unused RNRB to a surviving spouse if first of the couple to die: did not own a QRI OR did not qualify for the RNRB because they left a QRI to someone who was not a lineal descendant > capped at 100%
- Transferred RNRB only be used if surviving spouse leaves a QRI to a direct descendant
- Where a full transfer occurs, an estate may qualify for a RNRB of £350,000 (£175,000 + £175,000)
Downsizing = rules which allow an estate to qualify for a full RNRB even if the deceased did not own a QRI when they died IF:
- deceased must have given away their QRI or downsized to a less valuable QRI on or after July 2015
- former home would have been a QRI if it had been retained
- direct descendant inherits the replacement QRI and/or other assets
claim for the downsizing addition is made by the PRs within 2 years of the end of the month of death, not when the sale/gift of the former home takes place
CALCULATING IHT
LIFETIME TRANSFERS - tax due on an immediately chargeable lifetime transfer / tax due as a result of the transferor dying within seven years of making a lifetime transfer (LCTs and failed PETs)Step A: Calculate cumulative total
- Adding up the value of all chargeable transfers made in the 7 years prior to the transfer to establish how much of the nil rate band (‘NRB’) is available for the transfer
STEP B: Identify value transferred by chargeable transferSTEP C: Apply exemptions and reliefsSTEP D: Apply basic NRB and calculate tax
- Basic NRB can be applied against the
remaining taxable value > Establish the value of the NRB LESS by the value of the cumulative total (from Step A)
- Apply a rate of 0% to the value of the remaining taxable estate up to the total NRB amount
- Apply the relevant rate to the rest to establish the IHT due.
- LCTs: When calculating the tax due immediately on an LCT, the tax is payable at the lifetime rate of 20% so Step D is the final step in the calculation
- Failed PETs and re-assessed LCTs: Tax is payable at the death rate of 40% > If transferor dies 3-7 years after making the transfer + apply taper relief at the relevant rate to reduce the IHT payable
- RNRB never applies to lifetime transfers BUT NRB applicable to an LCT when it is first made is NRB at the date of transfer
- NRB that applies to a failed PET or re-assessed LCTis the NRB at the date of death.
Step E: Taper relief
- FOR PET or LCT being reassessed >applying taper relief to transfers made 3-7 years before the death
- 0-3 years > NO taper applies > 100% IHT payable
- 3-4 years > 20% IHT reduction > 80% IHT payable
- 4-5 years > 40% IHT reduction > 60% IHT payable
- 5-6 years > 60% IHT reduction > 40% IHT payable
- 6-7 years > 80% IHT reduction > 20% IHT payable
Step F: Giving credit for tax paid in lifetime
- deducting IHT paid previously from that due as a result of the death = only balance is paid
DEATH ESTATEStep 1: Calculate the cumulative totalStep 2: Identify the taxable death estate
- All property to which deceased was beneficially entitled at the date of death is included in the estate for IHT purposes like
Assets included:
- Jointly owned property = if deceased owned property as a tenant in common > share passes into deceased’s estate for both tax / distribution purposes // if deceased owned property as joint tenants with another/others > distribution of the property and the tax position are considered separately
- Property subject to a reservation = person gives an asset away during their lifetime but reserves a benefit in that asset > value of asset at date of death will be included in the donor’s IHT estate BUT can avoid GROB by ensuring they do not derive any benefit / paying a market value rent
- Donationes mortis causa = lifetime gift which is made conditional on death
- Statutory nominations = written nomination of monies in Friendly / Industrial / Provident Society each account must not exceed £5,000
- Interests in possession trusts = IF created before 22 March 2006 included in the life tenant’s taxable estate BUT IF created on or after 22 March 2006 if a life interest trust is created following someone’s death + life tenant with an immediate post death interest dies > capital value of the trust is included in their taxable death estate OR new inter vivos life interest trust is created > life tenant’s interest is not included in their taxable estate
Assets excluded:
- Excluded property = remainder interest in a life interest trust if remainderman before life tenant > trust fund that would have passed to them on the life tenant’s death is not included in the remainderman’s taxable estate
- Insurance policy written on trust for 3P = proceeds of the policy are not included in the deceased's estate for IHT purposes BUT if policy proceeds were payable to the deceased’s estate then the amount would be included in the taxable estate
- Discretionary pension schemes = discretionary lump sum payment made by the pension fund trustees is not included in the taxable estate BUT if payable to estate > included
Step 3: Value the taxable estate
- Assets in estate are valued at market value at date of death. Special rules for:
- Related property: assets owed by spouses are worth more when valued together > each party’s share valued at their proportionate share of combined pair.
- Joint property: land is co-owned > value of deceased’s share is reduced (by 10-15%) to reflect the difficulty of selling a share of the property rather than the whole.
Step 4: Deduct any debts
- deceased’s debts due at the date of death + Post-death debts/expenses (only funeral)
Step 5: Deduct available exemptions/reliefsStep 6: Apply the RNRB
- This includes the transferred RNRB if applicable > Apply a rate of 0% to the value of the taxable estate up to the total RNRB amount
Step 7: Apply basic NRB and calculate the tax
- Once you have considered the RNRB, the basic NRB and transferred NRB can be applied against the remaining taxable value:
- Establish the value of the NRB and any transferred NRB LESS cumulative total
- Apply a rate of 0% to the value of the remaining taxable estate up to the total NRB amount.
- Apply the death rate of 40% to the rest to establish the IHT due
Tax primarily paid on the estate of a deceased person:
- Nil rate band: 0%
- Lifetime rate: 20%
- Death rate: 40%
IHT is payable on the value transferred by a ‘chargeable transfer’
- Chargeable transfer =‘transfer of value’ made by an individual which is not an exempt transfer
- Transfer of value = ‘disposition’ which decreases value of the individual’s estate > gifts but it can also include transactions at an undervalue
The ‘value’ of a transfer of value depends on the trigger event:
- For lifetime transfers = loss in value to the donor
- For death estate = market value of items in the estate on the date of death
Cumulation is used to prevent individuals reducing their IHT liability by making a series of separate dispositions
- Cumulative total = Total chargeable value of all the chargeable transfers made in the previous 7 years
IHT trigger events
- Potentially exempt transfers (‘PET’)
- Lifetime transfers of value to another individual which could become chargeable to IHT depending on if transferor survives for 7 years after the transfer > transfer is not chargeable at point it is made
- Failed PETs (transferor does not survive for 7 years) are chargeable
- IF surfed = fully exempt transfer
- Lifetime Chargeable Transfers (‘LCT’)
- Lifetime transfers of value into a trust on or after 22 March 2006 immediately chargeable to IHT at lifetime rate
- If the transferor survives 7 years following LCT = no further charge to tax
- If the transferor dies within 7 years = LCT reassessed to tax at the death rate of 40%
- Death
- When person dies > deemed transfer of all assets that they own + IHT is chargeable on this transfer of value at death rate of 40% of value of estate above available NRB
- any PETs or LCTs made in the 7 years before death must be re-assessed to IHT as well