Inheritance Tax Allowances, Reliefs and Exemptions
There are a number of Allowances, Reliefs and Exemptions which can be applied to your Estate that will significantly reduce your Inheritance Tax liability. The following is a summary the current Allowances, Reliefs and Exemptions that are available.
You should of course always take professional advice on the applicability of these allowances in your own particular circumstances.
The Nil Rate Band
The Nil Rate Band (NRB) is the threshold above which Inheritance Tax is charged on an individual’s net Estate value at the time of death. It is applied in a similar way to personal Income Tax allowances.
The NRB for each individual for the tax year 2008/9 is £312,000 (rising in stages to £350,000 in year 2010/11). So there is no Inheritance Tax (IHT) to be paid on individual net Estate values up to and including £312,000. Currently, IHT at a rate of 40% is payable on the balance of the Estate above the NRB.
In addition, with effect from 9th October 2007, any portion of NRB unused when a spouse or civil partner dies may be transferred to the surviving spouse or civil partner and used when calculating their liability for Inheritance Tax when they die.
The actual amount of NRB to be transferred is calculated by assessing the proportion (as a percentage) of the NRB that was unused at the time of the first death and applying the same proportion to the current NRB available at the time of the second death.
So, given that any transfer of assets between spouses or civil partners is exempt from IHT (see below), if a spouse or civil partner dies and leaves all of his or her estate to the surviving spouse or partner, the NRB threshold for the surviving spouse or civil partner would be double the then current individual NRB level.
Example 1: Mike and Mary are a married couple. Mary dies in 2008 and leaves her entire estate to Mike. So there is no liability for IHT and 100% of the NRB applicable to Mary (£312,000 in the 2008/9 tax year) remains unused. When Mike dies some years later, the NRB threshold has risen to £325,000. 100% of the NRB in relation to Mary is transferrable, so the NRB applicable to Mike’s estate becomes £650,000 (£325,000 + £325,000).
Example 2: When Mary dies she leaves assets of £156,000 to the children and everything else to Mike. So one half (50%) of her NRB is used leaving 50% available for transfer. When Mike dies some years later, the NRB threshold has risen to £325,000. 50% of the NRB in relation to Mary is transferrable, so the NRB applicable to Mike’s estate becomes £487,500 (£325,000 + £162,500).
Gifts and Associated Exemptions
Some gifts to certain beneficiaries are not subject to IHT. Others are subject to IHT but the rate of tax reduces to zero over a number of years through the application of what is called Taper Relief (see below).
Gifts or transfers of assets to the following beneficiaries are exempt IHT:
• Spouse/civil partner
• Charities
• Political Parties
• Universities
• Certain institutions for national purposes (for example the National Trust)
Additional IHT exemptions include:
Annual Exemptions - Individuals can give away up to £3000 per tax year. This exemption is backdated by one year in any given tax year so if the £3000 limit is not used the balance can be used in the next year. (i.e. if the £3000 is not used, a total of £6000 may be given away in the next year).
Small Gift Exemptions - gifts of up to £250 can be made to any number of individuals.
Normal Expenditure Exemption - gifts that are considered to be made from income. These gifts must be made regularly (say annually or monthly) and must come from genuine income after tax (as opposed to capital). Good examples are Birthday presents or the payment of Insurance Policy premiums. There is no upper limit on the amount which can qualify for this exemption.
Marriage or Civil Partnership Exemption - gifts made by certain individuals in the case of a Wedding or Civil Partnership as follows:
• Parent – up to £5000
• Grand Parent – up to £2500
• Others – up to £1000
Potentially Exempt Transfers
Generally most gifts that do not fall into the above categories are considered Potentially Exempt Transfers commonly referred to as PETs. The IHT rate applicable to these gifts depends upon the number of years that have passed between the date the gift was given and the giver’s death.
The rate of tax to be paid has a sliding scale of relief applied to it over seven years which effectively reduces the rate to zero. This is called Taper Relief which is applied as follows:
Years between gift and death |
Reduction in Tax Applicable |
|
0-3 |
0% |
|
3-4 |
20% |
|
4-5 |
40% |
|
5-6 |
60% |
|
6-7 |
80% |
|
7 |
100% |
Note: Taper relief only reduces the tax payable where the total of gifts in the previous seven years is greater than the applicable Nil Rate Band.
Here is a worked example of how the application of Taper Relief can reduce the amount of IHT to be paid:
A widower, Mr. Jones, gave his son £412,000 as a gift 5 years and 6 months before he died. The value of Mr. Jones’ estate when he died was £500,000 made up of £200,000 for his house and £300,000 in other assets.
Because Mr. Jones died less than 7 years after he gave the £412,000 to his son, the gift is still regarded as part of his Estate for IHT purposes. So the total value of his estate is regarded as £912,000.
Mr. Jones did not receive any transferrable Nil Rate Band (NRB) from his spouse so the NRB applicable to his estate is £312,000. When the £312,000 NRB is applied to the value of the gift, £100,000 remains liable for Inheritance Tax, which qualifies for Taper Relief as follows:
Item |
Amount |
Gift to son |
£412,000 |
| Nil Rate Band (2008/9 rate) |
- £312,000 |
| Therefore total of gift liable for IHT |
£100,000 |
|
Tax Rate for IHT (2007/08)
|
x 40%
|
| Therefore tax payable without Taper Relief would be |
£40,000 |
|
Taper Relief rate after 5½ years(see table above)*
|
x 60%
|
| Therefore amount of Taper Relief |
£24,000 |
|
Tax payable before Taper Relief applied
|
|
| Taper Relief |
- £24,000 |
Tax payable after Taper Relief applied
|
£16,000 |
|
* The gift was made 5½ years before death, therefore the discount is 60% of the tax due
|
In this case the remainder of Mr. Jones Estate (£500,000) will be liable for IHT at the standard rate of 40%.
There are also different classes of gifts which may affect you, particularly Chargeable Lifetime Transfers (CLTs) and Gifts With Reservation (GWRs) as well as additional tax reliefs available for the transfer of businesses. Please contact us for further information about these items and how they may be able to benefit you.
Whatever your particular situation, you should always take professional financial advice when considering any options relating to IHT.
If you would like to speak to an adviser about reducing your IHT liability or arrange a no commitment consultation then contact us on 0845 0532965 or alternatively please use the Contact Us form.
Remember, the worst thing you can do is nothing – the government will benefit from your estate rather than your loved ones!