Inheritance tax (IHT) is a tax that is levied on the estate of a person who has passed away. The tax is paid on the value of the estate above a certain threshold, which is known as the inheritance tax threshold or nil-rate band.
In the UK, inheritance tax is currently set at 40% and is payable on estates valued above the threshold of £325,000. This is an additional inheritance tax allowance that applies to individuals who leave their main residence to their direct descendants (such as children or grandchildren) on their death. As of 2023, the allowance is £175,000 per person.
In addition to inheritance tax thresholds there are a number of inheritance tax exemptions and reliefs available that can reduce the amount of inheritance tax owed.
In this article we provide a brief overview of some of the inheritance tax exemptions and reliefs but it’s a complex area. If you are unsure of any aspect of IHT then book a free consultation with a probate solicitor.
Spouse/Civil Partner Exemption
One of the most common exemptions is the spouse or civil partner exemption. Gifts or transfers of assets between spouses or civil partners are generally exempt from inheritance tax, regardless of the value of the gift or transfer. This means that the surviving spouse can inherit their partner’s entire estate without any tax liability.
Gifts Exemption and Inheritance Tax
In the UK, lifetime gifts may be subject to inheritance tax if they are not covered by an exemption or relief. However, there is an annual exemption for lifetime gifts that allows individuals to give away a certain amount of money or assets each year without incurring any inheritance tax liability.
As of 2023, the annual inheritance tax exemption for lifetime gifts is £3,000 per tax year. This means that an individual can give away up to £3,000 worth of gifts each year without any inheritance tax being payable on those gifts. If the annual exemption is not used in a tax year, it can be carried forward to the following tax year, but only for one year.
In addition to the annual exemption, there are also other inheritance tax exemptions and reliefs that may apply to lifetime gifts. For example, gifts to a spouse or civil partner are generally exempt from inheritance tax, regardless of their value. Gifts to charities and political parties may also be exempt from inheritance tax.
It’s important to note that if a person makes a gift that is not covered by an exemption or relief, the gift may be subject to inheritance tax if the person dies within seven years of making the gift. This is known as the seven-year rule, and it means that any gifts made within seven years of death may be added back into the person’s estate for inheritance tax purposes.
However, the value of a lifetime gift may also be reduced over time by what is called “taper relief”, which reduces the amount of inheritance tax payable on gifts made more than three years before the person’s death.
Taper relief and inheritance tax
Taper relief is a tax relief that can apply to certain gifts made during a person’s lifetime that would otherwise be subject to inheritance tax in the UK. Taper relief reduces the amount of inheritance tax that is payable on gifts that were made more than three years before the person died.
The amount of taper relief that applies to a gift depends on the length of time between the gift and the person’s death. If a gift was made between three and four years before the person’s death, the inheritance tax rate is reduced by 20%. For gifts made between four and five years before the person’s death, the rate is reduced by 40%, and for gifts made more than five years before the person’s death, the rate is reduced by 60%.
For example, if an individual made a gift of £200,000 to their child six years before their death, and their inheritance tax threshold was £325,000, the gift would be subject to inheritance tax at a rate of 40%. However, because the gift was made more than five years before the person’s death, taper relief would reduce the inheritance tax rate by 60%, meaning that the tax rate would be reduced to 16%.
Overall, taper relief is a valuable tax relief that can help to reduce the amount of inheritance tax payable on gifts made more than three years before a person’s death.
Small gifts exemption
Small gift inheritance tax exemptions allow individuals to give away up to £250 to as many people as they like each year without incurring any inheritance tax liability.
Charitable donations
Gifts to charities and certain other types of non-profit organisations may be exempt from inheritance tax. The charity exemption means that if an individual leaves a gift or donation to a UK registered charity in their will, or transfers assets to a charity during their lifetime, the value of that gift or donation will be deducted from the value of their estate before inheritance tax is calculated. This means that the gift or donation will be exempt from inheritance tax, regardless of its value.
There are various types of gifts and donations that can qualify for the charity exemption, including cash gifts, shares or property, and gifts made through a trust. However, it’s important to note that the charity must be a registered UK charity in order to qualify for the exemption.
Inheritance tax business property relief
If an individual owns a business or an interest in a business, they may be able to claim Business Property Relief (BPR), which can reduce the value of the business or interest for inheritance tax purposes. Business property relief (BPR) is a relief that can be applied to the value of certain business assets when calculating inheritance tax. This relief can reduce the amount of tax that is payable on an estate when someone passes away.
BPR can apply to a variety of business assets, such as shares in unquoted companies, certain types of land and buildings, and machinery and equipment used in a business. In order to qualify for BPR, the asset must have been owned by the deceased person for at least two years before their death and must have been used for a qualifying business purpose during that time.
The amount of BPR that can be applied to an asset depends on the type of asset and the length of time it has been owned. For example, shares in a qualifying unquoted company may qualify for 100% relief from inheritance tax, while land and buildings used in a business may qualify for up to 100% relief depending on the length of ownership.
It’s important to note that BPR is subject to specific conditions and requirements and may not apply in all situations. It’s always a good idea to seek professional advice from a probate solicitor or tax specialist to determine whether BPR may apply.
Agricultural property relief and inheritance tax
If an individual owns agricultural property or shares in a farming business, they may be able to claim Agricultural Property Relief (APR), which can reduce the value of the property or shares for inheritance tax purposes.
APR can apply to a variety of agricultural assets, such as land, crops, farm buildings and livestock. In order to qualify for APR, the asset must have been owned by the deceased person for at least two years before their death and must have been used for a qualifying agricultural purpose during that time.
The amount of APR that can be applied to an asset depends on the type of asset and the length of time it has been owned. For example, land that is actively farmed may qualify for up to 100% relief from inheritance tax, while certain other agricultural assets may qualify for up to 50% relief.
It’s important to note that APR is subject to specific conditions and requirements, and may not apply in all situations. Seek professional advice from a probate or tax specialist to determine whether APR may apply.
Inheritance tax and the exemptions and reliefs are complex
What we provide here is a very brief overview of a complex topic. If you are dealing with probate and inheritance tax we strongly recommend that you take advice from a probate professional. The implications of wrong calculations are serious and can result in either an overpayment of tax which will deprive beneficiaries of their inheritance or an underpayment of tax which can leave the Executor or Administrator on the wrong side of HMRC and personally liable for the mistake.
