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What is inheritance tax?
Inheritance tax (IHT) is a tax payable on the value of a deceased person’s estate. Not everyone has to pay it. This is because normally there is no tax payable if the value of the estate is no more than £325,000 (the nil rate band) or everything over this amount is left to your spouse or civil partner. The rate of tax is normally 40%.
Residence nil-rate band
The ‘residence nil-rate band’ comes into effect if you leave your main residence to direct descendants such as children or grandchildren. This is in addition to the £325,000 allowance and is £175000, meaning IHT may not be due on the first £500,000 of an estate. However, the full amount of this residential allowance only applies if the estate is valued at less than £2 million. Above this figure the allowance decreases by £1 for every £2 above the £2m limit.
If the deceased was married or in a civil partnership and the estate is left to the surviving partner, the estate is exempt from IHT. Potentially this means a couple between them could leave up to £1 million free of IHT based on each individual’s £325,000 tax free allowance (i.e., £650000) plus both their main residence allowances (i.e., £350000).
Inheritance tax exemptions
The value of an estate includes everything owned at the date of death and the value of any gifts made within the preceding seven years. However, there are exemptions that can reduce or eliminate a potential IHT liability. There are some business assets that qualify for relief but for most people the most important exemptions relate to gifts.
What is a gift?
A gift of any amount will fall outside of the value of an estate for IHT purposes as long as the donor survives for a further seven years. If the survival period is less than seven years the gift will form part of the estate. If the gift takes the estate over the nil-rate band the excess will be liable to IHT. For gifts made three to seven years before death the amount that forms part of the estate is reduced on a sliding scale known as ‘taper relief’. IHT is not payable at the time of the gift.
There are other exemptions relating to gifts. One-off gifts of £250 can be made to as many people as wished as long as the recipient has not also received some or all of a £3000 annual exemption. Under this exemption, £3000 per annum can be gifted to either one person or split among a number of persons and can be used on a regular basis.
Tax free gifts of between £1,000 and £5,000 can be made to someone who is getting married or entering a civil partnership depending on their relationship to the donor.
If a person’s income is more than sufficient to meet daily needs any excess can be gifted to others and will not form part of the estate. These gifts should not reduce the donor’s standard of living.