What is Inheritance Tax and How Does it Work?

23 July 2018

By Probate Case Manager, Angela Mui

Inheritance Tax is a tax that may be payable upon a person's death. Whether or not Inheritance Tax needs to be paid will depend on several factors, including the value of the deceased person's Estate, and who will be inheriting this. If Inheritance Tax does need to be paid, then this will come out of the Estate funds. The Executor or Administrator of the Estate will be personally responsible for ensuring that any Inheritance Tax due is paid.

With our Probate Complete Service we take full responsibility for getting Grant of Probate and dealing with the Legal, Tax* (excluding VAT), Property and Estate Administration affairs.

*We deal with the Inheritance Tax, Capital Gains Tax and Income Tax matters of the deceased, and we deal directly with HM Revenue & Customs on your behalf.

Inheritance Tax Threshold - The Nil Rate Band

If the gross value of the Estate is under the Inheritance Tax threshold of £325,000 (known as the nil rate band) then Inheritance Tax will not need to be paid. If the value is over this threshold, then Inheritance Tax might be payable.

Valuing an Estate

When determining the value of an Estate, all of the assets which the deceased owned or was beneficially entitled to at their date of death will be taken into account.

As such, if the deceased owned a property in their sole name, the value of the property will be added to the total value of any other assets in the Estate. These might include bank accounts, personal possessions, investments and shareholdings to name a few. In some cases, the value of the property can push the value of the Estate over the nil rate band. In many Estates the property will be the main asset.

Inheritance Tax Exemptions

For some Estates, one or more of the following Inheritance Tax exemptions may be applied:

  • Spouse or charity exemption
  • Transferable nil rate band
  • Residence nil rate band
  • Transferable residence nil rate band

Spouse or Charity Exemption

There are certain exemptions which can be applied to reduce or negate the Inheritance Tax (IHT) liability on an Estate. For any amount that is above the nil rate band, Inheritance Tax will be charged at 40%. However, if at least 10% of the net Estate is left to charity, Inheritance Tax will be payable at a reduced rate of 36%.

If the whole Estate is being left to charity, then no IHT will be payable, regardless of the Estate's value, because charities are 'exempt Beneficiaries.'

Similarly, if the whole of the Estate is being left to the deceased's spouse or civil partner, then no IHT will be payable here either, as spouses and civil partners are also exempt beneficiaries.

So, no IHT would be payable in either of these circumstances as long as the value of the Estate is below £1 million.

Transferable Nil Rate Band

In situations where a pre-deceased spouse left their Estate to their husband or wife, then they will not have used any of their £325,000 nil rate band, as they left their Estate to an exempt Beneficiary. Upon the second person's death, a 'transferable nil rate band' can often be applied. This means any unused proportion of the first spouse's allowance can be transferred to the second spouse's Estate.

Therefore, this currently means that upon the second death, there could be a total nil rate band of up to £650,000 applied to the Estate. Any amount above this would be subject to IHT.

Residence Nil Rate Band

The residence nil rate band is relatively new, having been introduced from 6 April 2017. This allowance will be available when a residential property is left to direct descendants. In effect, the residence nil rate band is an additional IHT threshold, which can be added on to any other nil rate bands that have already been applied.

For 2018 to 2019, the maximum value of residence nil rate band which can be applied to an Estate is £125,000. This will increase by £25,000 each tax year until it reaches £175,000 in 2020.

For example, in the 2018-19 tax year, if a property is left to the children or grandchildren then the residence nil rate band of £125,000 can be added on to the original nil rate band of £325,000. This means that the total threshold will increase to £450,000.

Transferable Residence Nil Rate Band

As with the nil rate band, the residence nil rate band can also be transferred between spouses or civil partners. This is referred to as the transferable residence nil rate band.

The transferable residence nil rate band can be applied if the deceased had a spouse or civil partner who died before 6 April 2017, as the residence nil rate band did not apply before this date. The transferable residence nil rate band can also be applied if the spouse or civil partner died after this date but did not use all of their available residence nil rate band.

If the above exemptions have already been applied or are unavailable, and the Estate value still falls above the total threshold, then Inheritance Tax will need to be paid.

Inheritance tax is normally paid from the funds in the Estate to HM Revenue & Customs. It is payable by the person who is dealing with the Estate. This is the Executor if there was a Will or the Administrator if no Will was made.

This person can be held personally responsible for any errors that have been made in calculating the amount of IHT due or failing to pay this. Inheritance Tax does not normally need to be paid by the Beneficiaries of an Estate.

Co-op Legal Services is the largest provider of Probate and Estate Administration services in England and Wales, trusted to deal with over £1.3 billion in Estates annually.

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