3 - IHT: The Charge to IHT Flashcards
What is Inheritance Tax (IHT) and what is its purpose?
- Inheritance tax (IHT) is a tax paid on the estate of a deceased person. It applies to the UK assets of UK resident taxpayers and the worldwide assets of UK-domiciled taxpayers.
- When someone dies, certain events during their lifetime can also give rise to an IHT charge.
- The rates of tax differ based on the nature of the IHT trigger event. The Inheritance Tax Act 1984 (IHTA) aims to prevent avoidance by reducing estate value before death.
What are the rates of IHT for the current tax year?
The rates of IHT are set annually by the budget for the tax year, which runs from 6 April one year to 5 April the next.
For the current tax year, the rates are:
- Nil rate band: 0%
- Lifetime rate: 20%
- Death rate: 40%
What are the IHT trigger events?
There are three types of IHT trigger events:
Potentially exempt transfers (PET): Lifetime transfers that may incur IHT if the transferor does not survive for seven years.
Lifetime Chargeable Transfers (LCT): Lifetime transfers immediately chargeable to IHT at the lifetime rate, reassessed if the transferor dies within seven years.
Death: At death, all assets owned by the deceased are deemed transferred, triggering IHT (s 4 IHTA).
What are transfers of value?
IHT is payable on the value transferred by a ‘chargeable transfer’ (s 1 IHTA).
- A chargeable transfer is a ‘transfer of value’ made by an individual that is not an “exempt transfer” (s 2(1) IHTA).
- A “transfer of value” is a ‘disposition’ that decreases the value of the estate (s 3(1) IHTA).
This generally means gifts but can include transactions at undervalue (e.g., selling property for less than its worth). It applies to gifts of all forms of property.
What are nil rate bands (NRB)?
- Individuals have a basic nil rate band of £325,000 (NRB), allowing chargeable transfers up to this amount at 0% (no tax).
- Surviving spouses or civil partners can inherit any unused portion of their basic NRB, known as the ‘transferable nil rate band’ (TNRB).
- There is also a residence nil rate band (currently £175,000) for individuals who die on or after 6 April 2017 if they leave their family home to direct descendants.
What is a potentially exempt transfer (PET)?
A PET is a lifetime transfer of value. If the individual (the transferor) doesn’t survive for seven years after the transfer, it becomes chargeable alongside their death estate.
- The transfer is not chargeable at the time; no IHT is due.
- It becomes fully exempt if the transferor survives seven years from the PET date.
- If the transferor dies within seven years of making the PET, it becomes chargeable to IHT.
What is a lifetime chargeable transfer (LCT)?
All lifetime transfers of value into a trust on or after 22 March 2006 are LCTs.
- An LCT is chargeable at the time it is made, with IHT due at the lifetime rate of 20%.
- If the transferor survives seven years, there is no further tax.
- If the transferor dies within seven years of making the LCT, the LCT is reassessed to tax at the death rate of 40%, using the NRB at the date of death. E.g., £325,000 (NRB) minus the amount remaining is IHT chargeable at 40%.
How does death impact IHT? Provide an example comparing lifetime and death.
- When a person dies there is a deemed transfer of all the assets that they own at the date of their death (s 4 IHTA).
- It is this deemed transfer that gives rise to the IHT charge on death.
- Property in the taxable estate is valued at the price it might reasonably be expected to fetch if sold on the open market immediately before the death (s 160 IHTA).
- The taxable death estate is not the same as the succession estate so a separate calculation of the value of the estate for IHT purposes will be needed.
- IHT is payable on a person’s death estate at the death rate of 40% of the value of the estate above the available NRB.
- In addition to the IHT for the death estate, any PETs or LCTs made in the 7 years before death must be re-assessed to IHT as well.
Example:
Lifetime Chargeable Transfer Example: An LCT with a value of £500,000 is taxed as follows:
£0 to £325,000 (nil rate band): £0
£325,000 to £500,000 (lifetime rate): £175,000 x 20% = £35,000
Death Estate Example: A death estate valued at £500,000 is taxed as follows:
£0 to £325,000 (nil rate band): £0
£325,000 to £500,000 (death rate): £175,000 x 40% = £70,000
What is cumulation?
Cumulation prevents reducing IHT liability by making separate dispositions. Instead of viewing each chargeable transfer (i.e., failed PET, LCT, death) in isolation, HM Revenue & Customs (HMRC) considers IHT transfers made in the seven years prior.
Example: A man died last month after making two lifetime gifts in the last seven years:
Last year: Cash gift valued at £50,000 (a PET).
Two years ago: Shares valued at £100,000 (a PET).
The cumulative total on death is £150,000, reducing the NRB accordingly (£325,000 - £150,000), resulting in an available NRB of £175,000 on death.
How do you calculate the cumulative total and the available NRB?
Cumulative total = total chargeable value of all chargeable transfers made in the previous 7 years.
Available NRS = Full NRB - Cumulative total
What are exemptions and reliefs to IHT?
Various exemptions and reliefs can reduce or eliminate IHT:
- Gifts to certain individuals or entities are exempt, meaning they do not use up the NRB.
- Specific assets benefit from reliefs, reducing the IHT payable.
- Some exemptions and reliefs apply only to PETs and LCTs, while others apply to the death estate.
What is the formula for calculating IHT due on a failed PET or LCT?
To calculate IHT due on a failed PET or LCT, follow this formula:
- Identify value transferred.
- Apply exemptions & reliefs.
- Identify chargeable value.
- Calculate and apply NRB.
- Apply tax rates.
Summary of introduction to IHT.
IHT is a tax that is primarily paid on the estate of a deceased person at a rate of 40% but there are also lifetime trigger events.
A PET is a lifetime gift to another individual. It is exempt unless the transferor dies within 7 years, in which case it is charged at the death rate of 40%.
An LCT is a lifetime gift into a trust. It is an immediately chargeable transfer. An LCT is taxed at the lifetime rate of 20% but reassessed and charged at the death rate of 40% if the transferor dies within 7 years.
There is a nil rate band of £325,000. Individuals also have an additional nil rate band if they dispose of their family home to direct descendants. The unused portions of both nil rate bands are transferable to the deceased’s surviving spouse.
When calculating IHT it is necessary to take into account the cumulative total of chargeable transfers made in the last 7 years to determine the value of the NRB.
Exemptions and reliefs may be available to reduce an IHT liability.
What is the purpose of the transfer of the basic nil rate band (TRNB)?
The TRNB allows a surviving spoue to take advantage of the unused portion of the deceased’s basic NRB.
How does the TRNB work?
How it works: When a married individual dies (TNRB) allows a surviving spouse to use any unused tax-free allowance (NRB) from their deceased spouse when they pass away.
Calculation: The TNRB is calculated as a percentage of the NRB at the time of the survivor’s death, not simply the unused amount carried forward.
If the NRB has increased between the first and second death, the estate of the surviving spouse benefits from the higher NRB threshold.
Example: If the NRB was £312,000 when the first spouse died and increased to £325,000 by the time the second spouse died, and the first spouse used 50% of their NRB, the transferable amount would be 50% of £325,000, which equals £162,500.
Note: If the NRB amount remains unchanged between the two deaths, both the unused amount and percentage will stay the same.
What is the effect of outliving multiple spouses in relation to the transferable nil rate band (TNRB)?
When a person outlives multiple spouses, they can claim a TNRB from all spouses, subject to a cap of 100% of a full nil rate band.
The surviving spouse’s PRs (Personal Representatives) can claim up to 100% of the full NRB from multiple deceased spouses.
Example:
- A and B were married. B died, using 20% of his NRB (leaving 80% unused).
- A then married C, who later died, using 50% of C’s NRB (leaving 50% unused).
- A’s PRs can claim 80% from B and 50% from C, but the total is capped at 100% (one full NRB of £325,000).
- A’s PRs can claim A’s own NRB plus 100% TNRB, increasing A’s NRB from £325,000 to £650,000.
How can the Transferable Nil Rate Band (TNRB) be passed to a new spouse?
- When a spouse dies and their NRB remains unused, the surviving spouse can inherit that unused portion as part of their TNRB.
- If the surviving spouse then marries again and passes away, the TNRB can be claimed by the new spouse’s estate.
Example: A died 15 years ago, survived by wife B. A left all assets to B, meaning A’s NRB was unused. B married C five years ago and died, leaving 50% of her NRB unused. C’s estate can claim TNRB from B’s estate, combining B’s unused NRB and A’s full NRB to increase C’s NRB to £650,000.
What is the process for making a claim for the Transferable Nil Rate Band (TNRB)?
No claim needs to be made when the first spouse dies.
The PRs of the surviving spouse must make a claim for the TNRB in the IHT return within two years of the end of the month of death or within three months of the PRs first acting, whichever is later.
If they fail to do so, others liable for IHT on the surviving spouse’s death can make the claim after the deadline. HMRC has discretion to extend the deadline.
Note: A separate claim must be made for each TNRB if the individual has outlived multiple spouses, even if the cap means only one TNRB might be needed.
What is the Residence Nil Rate Band (RNRB)?
The RNRB provides an additional nil rate band where the following conditions are satisfied:
- The deceased died on or after 6 April 2017, their death estate included a ‘qualifying residential interest’ (QRI), and the QRI was ‘closely inherited’ by a ‘direct descendant’.
Example: If a parent leaves their home to their child, and the estate meets the RNRB conditions, the estate can benefit from an additional £175,000 nil rate band on top of the basic NRB.
What is the amount of the Residence Nil Rate Band (RNRB)?
- The full amount of the RNRB is £175,000. If the deceased’s share in the property is worth less than £175,000, the RNRB is capped at the value of the property.
- There is also a tapered withdrawal of the RNRB for estates with a net value exceeding £2 million, reducing the RNRB by £1 for every £2 above the threshold.
Note: There is no RNRB available for estates worth £2,350,000 or more (or £2,700,000 with a full transferred RNRB).
What qualifies as a Qualifying Residential Interest (QRI) for the Residence Nil Rate Band (RNRB)?
- A QRI is a residential property interest that is part of the deceased’s estate immediately before death.
- If the deceased owned multiple residential properties, their PRs must nominate one as the QRI. A residential property interest includes a dwelling-house where the deceased lived or intended to live.
Note: It does not include rental investment properties where the deceased never lived.
What does it mean for a beneficiary to ‘closely inherit’ under the RNRB?
- A beneficiary closely inherits from the deceased if they receive the QRI by gift under the will, through intestacy, or the rules of survivorship.
- There are additional circumstances where close inheritance applies, but generally, contingent interests do not qualify.
Note: For example, if a grandchild receives a property contingent on reaching a certain age, they do not closely inherit for RNRB purposes.
Who qualifies as a direct descendant for the purposes of the Residence Nil Rate Band (RNRB)?
Direct descendants include the deceased’s children and their descendants, such as grandchildren. Stepchildren are also considered direct descendants if they were financially dependent on the deceased at the time of death.
Example: If a grandchild inherits a property directly, they are classified as a direct descendant under the RNRB rules.
What are the conditions for transferring unused Residence Nil Rate Band (RNRB)?
The conditions for transferring unused RNRB are that the deceased must have died on or after 6 April 2017, the RNRB must not have been fully used, and the estate must pass to direct descendants. The transfer is capped at one full RNRB per estate.
Example: If a deceased person left a property to their child but did not use their full RNRB, the unused portion can be claimed by the child’s estate upon their death.
What are the rules allowing an estate to qualify for the full RNRB even if the deceased did not own a Qualifying Residential Interest (QRI) when they died?
The RNRB allows estates to qualify for the full RNRB even if the deceased did not own a QRI at death if they had downsized to a property of lesser value or sold their property before death. This is contingent on ensuring that the estate passes to direct descendants.
Example: If a deceased person sold their home and moved to a smaller property, their estate could still qualify for the full RNRB if it meets the necessary conditions.
What are the rules regarding the transfer of unused RNRB?
- Unused RNRB can be transferred from a deceased spouse or civil partner to their surviving spouse or civil partner, provided the original estate qualifies.
- The surviving spouse’s estate can benefit from the combined RNRB when they pass away, but the total transfer is capped at one full RNRB.
Example: If a couple’s combined estates have unused RNRB, the surviving spouse can benefit from it upon their death, subject to the cap.
What are the rules for RNRB downsizing, allowing an estate to qualify for full RNRB even if the deceased did not own a QRI when they died?
Rules allow an estate to qualify for a full RNRB even if the deceased did not own a QRI or if the value of their QRI is less than the RNRB.
These “downsizing” rules include:
- The deceased must have given away their QRI or downsized to a less valuable QRI on or after July 2015.
- The former home would have been a QRI if retained.
- A direct descendant inherits the replacement QRI and/or other assets.
The addition is calculated based on the RNRB lost due to the former QRI no longer being owned. Claims for the downsizing addition must be made within 2 years of the end of the month of death.
Where are the downsizing rules for RNRB note relevant?
The downsizing rules are not relevant if:
- There is no loss of the RNRB because the value of any new QRI in the estate is the same/more than the maximum available RNRB, or,
- The RNRB is not available, because the new QRI or assets are not left to a direct descendant
How can an estate qualify for a maximum combined NRB?
An estate can qualify for a total NRB amount of £1 million through the following scenario:
- A and B are married; A dies leaving all assets to B.
- A’s estate passes to B and is spouse exempt, resulting in no NRB usage at A’s death.
- B dies, leaving their estate worth £1 million, including a family home valued at £500,000.
B’s PRs can claim:
- B’s basic NRB of £325,000
- B’s RNRB of £175,000 (the house passes to a direct descendant)
- A’s unused basic NRB of £325,000
- A’s unused RNRB of £175,000
This totals a combined NRB of £1 million (£325,000 + £325,000 + £175,000 + £175,000), with no IHT payable on B’s death.
Provide a summary of IHT Nil Band Rates.
- Each individual is entitled to a basic nil rate band of £325,000 (‘NRB’). Chargeable transfers up to the value of the NRB are taxed at 0%.
- The NRB available is reduced by a person’s cumulative total. The cumulative total = total value of the chargeable transfers made in the previous 7 years.
- The PRs of a surviving spouse/civil partner can claim the unused % of the NRB of the pre-deceased spouse/civil partner (the transferred NRB (‘TNRB’)). The TNRB is capped at 100% of the basic NRB at the date of the survivor’s death.
- On death, an additional nil rate band of £175,000 can be claimed if the deceased left a ‘QRI’ to a direct descendant, referred to as the ‘residence nil rate band’ (‘RNRB’). There is a tapered reduction in the RNRB for estates worth more than £2 million.
- The PRs of a surviving spouse/civil partner can claim the unused % of the RNRB of the former spouse/civil partner (the transferred RNRB). The transferred RNRB is capped at 100% of the amount of the RNRB at the date of the survivor’s death.
- Estates without a QRI (or a QRI worth less than the maximum RNRB) might benefit from the downsizing rules.
