Understanding Inheritance Tax and allowances

Inheritance Tax (IHT) can be a difficult concept to comprehend, especially for those who have never had to attempt the complex process of dealing with a loved one’s taxable estate before. To put it simply, IHT is a tax that is paid upon an estate of someone who has died.

According to recent research by financial services firm NFU Mutual, there were 22,100 deaths in 2018/2019 which resulted in an average IHT bill of £209,502, an increase of 6% from £197,521 the previous year. The research revealed that Londoners paid the highest IHT in the country with an average bill of £271,820, while those in the North West were recorded as paying the lowest with an average bill of £152,898.

Not fully understanding the IHT process can cause several implications for Executor(s) and beneficiaries of an estate, such as monetary penalties, personal liability with HM Revenue and Customs (HMRC) and severe delays in distributing funds to beneficiaries. This blog aims to help you better understand Inheritance Tax by addressing the must-knows of this often-complicated process.

Who is responsible for paying Inheritance Tax?

Paying the Inheritance Tax that is due to HMRC forms part of the role and responsibilities of the person dealing with an estate, known as an Executor (if there is a Will) or Administrator (if there is no Will). In many cases, this can be paid using money from the estate, however, this may not always be possible. Once IHT has been paid, the Executor or Administrator can then distribute the assets as set out in the Deceased’s Will - or in line with the rules of intestacy, if there is no Will.

Considering an estate’s position - IHT thresholds and allowances

Inheritance Tax does not apply to all estates. Any part of an estate that passes to a spouse/civil partner or a charity is exempt from IHT. There are also a number of organisations that are typically exempt from the tax, including community amateur sports clubs.

Nil Rate Band (NRB)

IHT is paid on an estate that exceeds the value of the Nil Rate Band, also known as the IHT threshold. In other words, the NRB is the amount up to which no Inheritance Tax is payable. The current threshold is set at £325,000 per person (which is due to remain in place until 5^th April 2026).

Above this threshold, Inheritance Tax is currently paid at a rate of 40% except for estates that give 10% or more of their net estate to charity(s), in which case a reduced rate of 36% will be applied.

On the second death of a married couple/civil partnership, that person’s allowance plus the pre-deceased spouse/civil partner’s unused allowance can be claimed. If the first spouse/civil partner to pass away has passed everything to their partner, their full £325,000 Nil Rate Band can be used upon the second death. However, if on the first death some of the Deceased’s allowance was given elsewhere (e.g. children), only the difference can be claimed.

For example, Mr S died in June 2017 leaving 20% (£65,000) of his £325,000 Nil Rate Band to his only child as a legacy in his Will, everything else was then left to his spouse. On the death of the surviving spouse, Mrs S’s allowance (£325,000) can be claimed plus the remaining 80% (£260,000) of the Deceased’s allowance.

Residence Nil Rate Band (RNRB)

Since 2017, there is also an additional NRB that can be applied for when a property forms part of the estate – known as the Residence Nil Rate Band (RNRB). This is subject to specific rules set by HMRC for when this applies. The current threshold, also until 5^th April 2026, is £175,000. GOV.UK includes a calculator feature to help work out how much RNRB an estate may get, the RNRB available if a person downsized, or any unused RNRB for transfer to the estate. Even if a house was sold prior to death (but after 8^th July 2015), there may still be some RNRB available to reduce any Inheritance Tax that may be payable.

There are additional allowances that can be claimed, including Business Property Relief (BPR) and Agricultural Property Relief (APR) if business assets form part of the estate. However, these are dependent on the assets being applicable for relief under specific rules set by HMRC.

What are the differences between IHT forms?

Form IHT205

For those estates which do not have to pay Inheritance Tax but will need a Grant of Probate, the completion of the simpler IHT205 form is required. This form confirms that no IHT is payable but must be submitted to obtain the Grant of Probate (if there is a Will) or Letters of Administration (if there is no Will).

The form will confirm one of the following:

1. The overall estate value is under the £325,000 NRB threshold (or under the £650,000 threshold if the Deceased inherited an estate from a pre-deceased spouse or civil partner).
   
   
2. That the estate is an ‘excepted estate’. This means that the gross estate is valued at less than £1 million and left to a surviving spouse/civil partner, charity or organisation that makes it exempt from any IHT payment.
   
   

Form IHT217 (Claim to transfer unused Nil Rate Band for excepted estates)

Form IHT217 is specifically used on estates where the pre-deceased spouse left everything to their partner who survived them. There can be no legacies to other family members or friends. This form can be used to claim a transfer of unused Nil Rate Band for excepted estates (estates less than £650,000 which is the combination of two NRBs). This form must be accompanied by the corresponding IHT205 and must be sent no later than 24 months after the end of the month in which the Deceased died.

That said, if HMRC does not agree that the submission is an excepted estate, the wrong forms have likely been completed. Even worse, the submission deadline for the alternative and correct tax forms is shorter than the above which could result in fines and penalties for the Executor/Administrator. We would always recommend the completion of any IHT forms promptly to avoid any repercussions.

Form IHT400

For estates that are subject to Inheritance Tax, a more complex form that requires much more detail, known as form IHT400, is required. Before completing the IHT400, an IHT reference number and pay slip to make a payment is needed. This is obtained by completing form IHT422 or applying for it online. The IHT400 must be completed within a year of the date of death; however, any interest owed is payable after six months so shouldn’t be delayed. It’s worth bearing in mind that some estates require the completion of an IHT400, even if no tax is payable – this is known as NIL400 and may be required if specific questions are required by HMRC.

Form IHT402 (Claim to transfer unused Nil Rate Band)

This form is used with form IHT400 to claim any unused portions of the Nil Rate Band from a pre-deceased spouse or civil partner. Form IHT217 above can only be used where 100% of the estate on the first death passed to the surviving spouse/civil partner. Form IHT402 is used when some of the allowance has been used on the first death (e.g. some funds passed to children or other beneficiaries). This form allows the remaining allowance to be claimed. A calculation needs to be completed to work out the percentage of the used allowance (not the monetary amount) to understand the remaining percentage to carry forward.

Paying your Inheritance Tax bill

Inheritance Tax is due by the end of the sixth month after a person dies. For example, if the person died in January, you must pay the Inheritance Tax by 31^st July. However, there are different due dates if you are making payments on a Trust. HMRC will charge interest on any unpaid amounts once the six-month period has passed. If Inheritance Tax is not paid within six months, there will be additional charges on top of any tax due. If there is not sufficient cash to make the IHT payment at the six-month deadline, you can agree with HMRC to pay the tax over a ten-year period. If agreed, the amount of tax due is divided by ten and is paid over ten annual instalments – subject to interest.

Tax forms need to be sent to HMRC within twelve months from the date of death. Accounts submitted after this time may be given monetary penalties.

What is a gift and how does it impact Inheritance Tax?

A gift is anything that has value, such as money, household and personal goods, property, stocks and shares listed on a Stock Exchange, and unlisted shares held for less than two years before death. A gift can also include any money lost when something is sold for less than its worth. For example, selling your house to your child for less than its market value, the difference in value counts as a gift.

When is Inheritance Tax due on gifts?

IHT may have to be paid after death on gifts if the person who has died has not lived for seven years after the gift was made. Gifts do not count towards the value of the estate after seven years and will not be subject to IHT. Gifts made less than seven years before death may be taxed depending on:

• Who the gift is for and their relationship to the Deceased
• The value of the gift
• When the gift was given

Any Inheritance Tax due on gifts (after the NRB has been exhausted) is paid by the person receiving the gift. There is a taper that can be applied to gifts that are closer to reaching the seven-year period. The taper (which takes place over the last four years) means the tax would not be paid at 40% but at a lower rate, depending on how close to the end of the seven-year period the gift is made.

There is no Inheritance Tax to pay on gifts between spouses/civil partners. They can receive any amount during their lifetime as long as they live in the UK permanently and are legally married or in a civil partnership.

A gift with reservation of benefit (GROB)

A gift with reservation of benefit is not subject to the seven-year rule. If the Deceased has given something away but retained some benefit, the amount will remain in the estate and form part of the IHT calculation on death. For example, the Deceased changed the ownership of their property into their child’s name but continue to live there and pay no rent. As they were still enjoying the benefit of living in the property until their death (even if the transfer of ownership was done 20 years ago, as an example), HMRC will say this asset still forms part of their estate and must be included on the Inheritance Tax submission.

Exempt gifts

A total of £3,000 worth of gifts or money each tax year can be given away without them being added to the value of an estate – known as the ‘annual exemption’. The total can be given to one person or split between several people, but only £3,000 can be given away in total. Any unused annual exemption can be carried forward to the next tax year – but only for one tax year following a death.

A person can give as many gifts of up to the value of £250 per person each tax year, as long as another allowance hasn’t been used for the same person. Additionally, each tax year, you can give a tax-free gift to someone who is getting married or starting a civil partnership of up to £1,000 per person (this increases to £2,500 for a grandchild and £5,000 for a child). Gifts can be exempt if you can prove these were made from surplus income. To qualify, there is a separate tax form to be completed (IHT403 – an 8-page document) that requires a detailed breakdown of monthly income and expenditure before it can be approved.

Kings Court Trust is an award-winning probate and estate administration provider who can take care of the complicated practicalities after death. If you have any questions about probate or estate administration, call our experienced Client Services Team on 0300 303 9000.