Inheritance tax

Question 1

What is Inheritance Tax (IHT)?

Answer 1

Inheritance Tax (IHT) is a tax levied on the transfer of wealth from one individual to another, either during the individual’s lifetime or upon their death.

IHT applies to the value of a deceased person’s estate and certain gifts made during their lifetime, ensuring that a portion of their wealth is taxed before being passed on to heirs.

Question 2

How is Lifetime Tax defined in relation to IHT?

Answer 2

Lifetime Tax refers to the Inheritance Tax charged on certain gifts made during a person’s lifetime, specifically known as Chargeable Lifetime Transfers (CLTs), which are taxed at a rate of 20%.

Question 3

What assets can be subject to Death Tax?

Answer 3

Death Tax can be imposed at a rate of 40% on:

• Gifts made within the seven years leading up to an individual’s death.
• The total value of assets in the deceased’s estate at the time of death.

This means that both pre-death gifts and the estate itself can be taxed, potentially resulting in significant liabilities for heirs if not planned properly.

Question 4

Who is liable for Inheritance Tax?

Answer 4

Individuals who are UK domiciled or deemed UK domiciled are liable for IHT on their worldwide assets. In contrast, non-domiciled individuals are only liable for IHT on their UK-based assets.

Domicile status can significantly affect the extent of one’s tax liabilities and strategies for estate planning.

Question 5

What is the nil rate band for the tax year 2023/24, and how does it function?

Answer 5

The nil rate band for the tax year 2023/24 is £325,000. This means that any value below this threshold is not subject to IHT. When considering transfers, the nil rate band is assessed over a rolling 7-year period.

Understanding how the nil rate band functions is crucial for effective estate planning, as any use of this band within the 7-year timeframe will affect future transfers.

Question 6

What additional nil rate band applies when calculating Death Tax in the estate?

Answer 6

There is a residence nil rate band (RNRB) of £175,000 that can be claimed if the deceased’s home is included in the estate and is bequeathed to a direct descendant, such as children or grandchildren, after April 6, 2017.

The RNRB provides additional relief, potentially reducing the overall IHT liability on the estate, but is not available for lifetime transfers.

Question 7

Upon the death of one spouse, what benefits can the surviving spouse utilize?

Answer 7

The surviving spouse can utilize any unused nil rate band or residence nil rate band from the deceased spouse, effectively increasing their tax-free allowance when they pass away.

This provision allows for more efficient tax planning and can significantly lower the IHT liability for the surviving spouse’s estate.

Question 8

What types of lifetime transfers exist under Inheritance Tax regulations?

Answer 8

There are three main types of lifetime transfers:

• Chargeable Lifetime Transfer (CLT)– transfers that may incur IHT during the donor’s lifetime.
• Potentially Exempt Transfer (PET) – lifetime transfers that may become chargeable only if the donor dies within 7 years of the gift.
• Exempt Transfers (ET) – these include gifts to spouses, UK charities, or for national purposes, which are not subject to IHT.

Each type of transfer has different implications for tax liabilities and planning opportunities, underscoring the importance of understanding how each category functions.

Question 9

What qualifies as a Chargeable Lifetime Transfer (CLT)?

Answer 9

A Chargeable Lifetime Transfer is a gift made to a trust or individual that is subject to Inheritance Tax if the donor passes away within 7 years of making the gift.

Understanding CLTs is critical for individuals considering estate planning, as these transfers can trigger immediate tax implications.

Question 10

What is the purpose of a trust in relation to Inheritance Tax?What is a trust?

Answer 10

A trust is a legal arrangement where a trustee manages and holds assets for the benefit of a beneficiary, allowing for controlled distribution of assets according to specific terms set by the trustor.

Trusts can be effective tools in estate planning, providing protection for assets and potential tax advantages depending on their structure.

Question 11

When does a Chargeable Lifetime Transfer become liable for Inheritance Tax?

Answer 11

A CLT becomes liable for IHT during its lifetime, incurring tax at a rate of 20%. If the donor dies within 7 years of making the CLT, Death Tax may also apply.

Trusts can be effective tools in estate planning, providing protection for assets and potential tax advantages depending on their structure.

Question 12

What is a Potentially Exempt Transfer (PET)?

Answer 12

A Potentially Exempt Transfer is a lifetime gift between individuals that is not a CLT and is not specifically exempt. If the donor survives for 7 years after making the gift, it becomes completely exempt from IHT.

PETs are valuable for tax planning, as they allow for gifts to be made without immediate tax consequences, provided the donor survives the requisite period.

Question 13

What are the key characteristics of a Potentially Exempt Transfer (PET)?

Answer 13

• PETs incur no immediate tax liability.
• They only become subject to Death Tax if the donor dies within 7 years of the transfer.
• If the donor survives beyond 7 years, the PET is exempt from IHT.

These characteristics make PETs an essential consideration in effective estate planning, allowing individuals to transfer wealth without incurring taxes prematurely.

Question 14

What are the specific exemptions for lifetime transfers and transfers on death (Exempt Transfers)?

Answer 14

Certain gifts are exempt from Inheritance Tax, including:

• Gifts to a spouse or civil partner.
• Donations to recognized UK charities.
• Contributions for national purposes.
• Gifts to qualifying political parties.

Utilizing these exemptions can significantly reduce the IHT liability for both lifetime and posthumous transfers.

Question 15

What specific exemptions apply only to lifetime transfers?

Answer 15

The following exemptions apply exclusively to lifetime transfers:

1. Small Gifts Exemption – gifts up to £250 per recipient per tax year.
2. Marriage or Civil Partnership Exemption – gifts of varying amounts depending on the relationship (e.g., up to £5,000 from a parent).
3. Annual Exemption – the first £3,000 of transfers made in a tax year is exempt.

These exemptions can provide strategic benefits for individuals looking to manage their estate efficiently and minimize tax exposure.

Question 16

What is the Small Gifts Exemption?

Answer 16

The Small Gifts Exemption allows individuals to make gifts of up to £250 per donee (not including trusts) per tax year without incurring Inheritance Tax. If a single recipient receives more than £250 in total during the year, the exemption does not apply.

This exemption enables small, frequent gifts to be made tax-free, encouraging generosity while minimizing tax liabilities.

Question 17

What is the Marriage or Civil Partnership Exemption?

Answer 17

The Marriage or Civil Partnership Exemption permits gifts of specific amounts tax-free, including:

• Up to £5,000 from a parent.
• Up to £2,500 from a grandparent.
• Up to £2,500 between parties to the marriage.
• Up to £1,000 from any other individual.

This exemption is beneficial during wedding planning, allowing for significant gifts to be made without incurring tax.

Question 18

How does the Annual Exemption function in Inheritance Tax?

Answer 18

The Annual Exemption allows the first £3,000 of value transferred in a tax year to be exempt from IHT. This amount is applied against the first gift of the year, regardless of whether it’s a PET or CLT. Any unused portion can be carried forward for one year.

Strategically utilizing the Annual Exemption each year can help individuals gradually transfer wealth without triggering tax liabilities.

Question 19

What is allocated to lifetime transfers in strict chronological order, and why?

How is the Annual Exemption applied to lifetime transfers?

Answer 19

The annual exemption will be allocated to lifetime transfers in strict chronological order, meaning that if the first gift in the tax year is a PET, the AE will be used to reduce the value of the PET first, even though the PET may never become chargeable.

This highlights the importance of planning the sequence of transfers to ensure that the exemption is used optimally.

Question 20

What are the tax rates applied to Chargeable Lifetime Transfers (CLTs)?

Answer 20

• 0% up to the nil rate band.
• 20% on the excess over the nil rate band.

These rates show how taxes are calculated on larger transfers, emphasizing the benefit of keeping transfers below the nil rate band where possible.

Question 21

What amount is exempt from Inheritance Tax under the nil rate band?

Answer 21

The nil rate band is £325,000.

The nil rate band allows individuals to pass on assets worth up to this threshold tax-free, making it a key consideration in estate planning.

Question 22

How should one approach the calculation of lifetime tax on transfers?

Answer 22

1. Deal with all transfers in the tax year in chronological order.
2. Ignore exempt transfers.
3. Value the transfers.
4. Deduct:

• Marriage exemption.
• Annual exemptions (chronological order).

5. If the transfer is a PET, ignore it for now.
6. Calculate any tax due on CLTs.

Following these steps ensures a clear, organized process for calculating taxes on lifetime transfers.

Question 23

What transfers are subject to death tax?

Answer 23

Death tax is payable on lifetime gifts made in the 7 years before death.

This rule underscores the importance of surviving for 7 years after making significant lifetime gifts to avoid death tax.

Question 24

What happens to gifts made more than 7 years before death?

Answer 24

They are not chargeable to death tax but may impact the value of accumulated transfers, thereby reducing the nil rate band.

This shows the benefit of making gifts more than 7 years before death to minimize tax exposure.

Question 25

How does taper relief affect Inheritance Tax on gifts?

Answer 25

Taper relief reduces the IHT due on death if the donor survives at least 3 years after making the gift. The % reduction depends on the number of years the donor survived after the gift was made.

The longer the donor survives after making the gift, the greater the reduction in IHT due.

Question 26

Can lifetime tax paid earlier be offset against death tax?

Answer 26

It can be deducted from the death tax, reducing the tax to nil. However, it cannot result in a repayment.

This is useful for reducing the overall IHT burden, but no refund is possible if the tax paid exceeds the death tax liability.

Question 27

How should you calculate taper relief for gifts made before death?

Answer 27

1. Identify the PET and CLT within 7 years prior to death.
2. Work out the CGT (Capital Gains Tax).
3. Calculate DT (Death Tax).
4. Apply taper relief.
5. Deduct lifetime tax paid.
6. Repeat for each lifetime transfer.

These steps ensure that taper relief is calculated correctly for each relevant gift.

Question 28

What makes up the death estate for Inheritance Tax purposes?

Answer 28

The death estate consists of the assets (and liabilities) held at the time of the donor’s death and is chargeable to death tax. In effect, the donor is transferring the assets at the date of death to another individual(s), usually outlined in their will. The annual exemption is not available to set against the death estate.

The death estate is typically the total value of what is passed on at death and is fully subject to death tax, unlike some lifetime gifts.

Question 29

What is the rate of Inheritance Tax on the death estate?

Answer 29

Death tax is charged at 40%.

This rate applies to any portion of the estate exceeding the nil rate band, making it crucial to plan for IHT mitigation.

Question 30

What strategies can help reduce an individual’s Inheritance Tax liability?

Answer 30

• Give away assets now and hope to survive 7 years (or at least 3 years for taper relief).
• Use the £3,000 Annual Exemption each year.
• Use as many exemptions as possible, such as small gifts and marriage exemption.
• Use up the £325,000 nil rate band every 7 years.
• Remember transfers on death are exempt for CGT purposes but are chargeable to IHT instead.
• Avoid giving away assets during lifetime that will be chargeable to CGT and potentially chargeable again to IHT if death occurs within 7 years.
• Skip a generation: If a father gifts to a daughter, IHT may be payable on his death. Then the daughter may gift the same assets to her daughter, and IHT may be payable again. It would be better for the grandfather to gift directly to the grandchild.

These strategies are essential to avoid unnecessary taxes and preserve wealth across generations.