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Knowledge Base

Inheritance Tax

01 January, 2009

Inheritance Tax is the tax paid on your 'estate'. Broadly speaking this is everything you own at the time of your death, less what you owe. It's also sometimes payable on assets you may have given away during your lifetime. Assets include property, possessions, money and investments.

Depending on the exact circumstances it is possible to delay or reduce Inheritance tax. Inheritance tax and capital gains tax are sometimes referred to voluntary tax and with careful planning could be completely avoided. The best way to establish inheritance tax as a liability with the Inland Revenue is by completing the inheritance supplementary pages of a normal personal tax return.

Introduction to Inheritance Tax planning

Planning ahead for when you die allows you to set out clearly who should get what from your estate. It also means you can maximise Inheritance Tax reliefs and exemptions if your estate might be worth more than the Inheritance Tax threshold when you die (£312,000 in 2008-09).

The importance of making a will

Making a will and being sure people know where to find it is the first step to ensuring that your estate is shared out exactly as you want it to be when you die.

If you don't leave a will, your estate will be shared out among your next of kin according to a strict order of priority called the 'rules of intestacy'. This means that people you want to benefit from your estate - such as a partner you're not married to or in a registered civil partnership with - might get nothing.

You can write your will yourself or purchase a pre-printed form from many stationers or newsagents. It’s very important to sign your will and get the signature witnessed or it won't be valid.

If you have more complex financial affairs, you may need legal and financial advice.

Who pays Inheritance Tax:

Estates and lifetime gifts

Not everyone pays Inheritance Tax on death. It only applies if the taxable value of your estate (including your share of any jointly owned assets and assets held in some types of trusts) when you die is above £312,000 (2008-09 tax year). It is only payable on the excess above this nil rate band.

There are also a number of exemptions which allow you to pass on amounts (during your lifetime or in your will) without any Inheritance Tax being due, for example:

  • If your estate passes to your husband, wife or civil partner and you are both domiciled in the UK there is no Inheritance Tax to pay even if it's above the £312,000 nil rate band
  • Most gifts made more than seven years before your death are exempt (but see the next section on trusts and companies)
  • Certain other gifts, such as wedding gifts and gifts in anticipation of a civil partnership up to £5,000 (depending on the relationship between the giver and the recipient), gifts to charity, and £3,000 given away each year are also exempt

Transfers into trusts and companies

Transfers of assets into most trusts and companies are subject to an immediate Inheritance Tax charge if they exceed the Inheritance Tax nil rate band (taking into account the previous seven years' chargeable gifts and transfers). Follow the link below which deals with Inheritance Tax on an individual's estate on death.

Inheritance Tax exemptions - what you can give away

Gifts are treated in a number of ways for Inheritance Tax purposes. However, you only need to worry about making gifts if you think your estate - including the value of any gifts you make - might exceed the Inheritance Tax threshold when you die.

Giving your home away

There can be tax implications if you give your home away to your children or someone else - especially while you’re still alive.

If you give your home away and continue to live in it, your estate or the person you gave your home to might still have to pay Inheritance Tax on the property when you die, as well as other taxes.

Inheritance Tax relief for businesses and farms

Certain types of property can be passed on free from Inheritance Tax - or at a discounted value for Inheritance Tax purposes. This can be done while you’re still alive or through your will.

You may be able to claim special relief for the following assets:

  • Business assets - such as shares in a business partnership, land, buildings and machinery
  • Agricultural property - such as land, working farmhouses and barns
  • woodland timber
  • National Heritage property - or famous and important works of art (but only in very rare cases)

Trusts

You can use a trust to pass assets on to others, for example to those who aren't immediately able to look after their own affairs, such as your children.

Gifts into a trust may still be subject to Inheritance Tax if your estate, including the amount being transferred, is over the Inheritance Tax threshold (£312,000 in 2008-09).

Trusts can be complicated - it’s a good idea to get professional advice.

Gifts that are exempt from Inheritance Tax

If your estate is worth more than the Inheritance Tax threshold - £312,000 for the 2008-09 tax year - there are some important Inheritance Tax exemptions that allow you to make gifts to others and not have to pay tax on them when you die.

Exempt beneficiaries or 'donees'

You can make gifts to certain people and organisations without having to pay any Inheritance Tax. These gifts are exempt whether you make them during your lifetime or as part of your will.

You can make exempt gifts to:

  • Your husband, wife or civil partner, as long as they have a permanent home in the UK
  • UK charities
  • Some national institutions such as museums, universities and the National Trust
  • UK political parties

Gifts that you give to your unmarried partner, or a partner that you're not in a registered civil partnership with, are not exempt.

Annual exemption

You can give away gifts worth up to £3,000 in each tax year and these gifts will be exempt from Inheritance Tax when you die. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don’t use it in that year, the carried-over exemption expires.

The annual exemption is in addition to the other gift exemptions.

Exempt gifts

Some gifts made during your lifetime are exempt from Inheritance Tax because of the type of gift or the reason for making it.

Wedding or civil partnership ceremony gifts are exempt from Inheritance Tax, subject to certain limits:

  • Parents can each give cash or gifts worth £5,000
  • Grandparents and other relatives can each give cash or gifts worth £2,500
  • Anyone else can give cash or gifts worth £1,000

You have to make the gift - or promise to make it - on or shortly before the date of the wedding or civil partnership ceremony. If the ceremony is called off and you still make the gift - or if you make the gift after the ceremony without having promised it first - this exemption won't apply.

Small gifts

You can make small gifts up to the value of £250 to as many people as you like in any one tax year. However, you can’t give a larger sum and claim exemption for the first £250.

You can’t use your small gifts allowance together with any other exemption when giving to the same person.

Regular gifts or payments that are part of your normal expenditure

Any regular gifts you make out of your after-tax income, not including your capital, are exempt from Inheritance Tax. These include:

  • Monthly or other regular payments to someone
  • Regular gifts for Christmas and birthdays, or wedding/civil partnership anniversaries
  • Regular premiums on a life insurance policy - for you or someone else

You can also make exempt maintenance payments to:

  • Your husband, wife or civil partner
  • Your ex-spouse or former civil partner
  • Relatives who are dependent on you because of old age or infirmity
  • Your children, including adopted children and step-children, who are under 18 or in full-time education

The seven-year rule - 'potentially exempt transfers'

Any gifts you make to individuals will be exempt from Inheritance Tax as long as you live for seven years after making the gift. These sorts of gifts are known as 'potentially exempt transfers'.

If you die within seven years and the total value of gifts you made is less than the Inheritance Tax threshold, then the value of the gifts is added to your estate and any tax due is paid out of the estate.

However, if you die within seven years of making a gift and the gift is valued at more than the Inheritance Tax threshold, Inheritance Tax may be due on the gift. In this situation, the Inheritance Tax may need to be paid by the person who received the gift.

If you die between three and seven years after making a gift, and the total value of gifts that you made is over the threshold, any Inheritance Tax due on the gift is reduced on a sliding scale. This is known as 'Taper Relief'.

Gifts into trust

Gifts into trust are not generally exempt from Inheritance Tax. If the trust is for a disabled person, the transfer into trust counts as a potentially exempt transfer - it will be exempt from Inheritance Tax if you survive for seven years after making the gift.

The importance of keeping records

It will help your executor or personal representative to sort out your financial affairs when you die if you keep a record of any gifts you make and note on that record which exemption you've used.

It's also a good idea to keep a record of your after-tax income if you make regular gifts out of income as part of your normal expenditure. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.

Passing on your home to your children

You can give your home to your children - or someone else - at any time, even while you're still living in it. However, if your estate (including your home) is worth more than the Inheritance Tax threshold (£312,000 in 2008-09), there may be tax implications.

Inheritance Tax when passing on property

For Inheritance Tax purposes, giving your home away is treated as making a gift. The rules about passing on property are complicated, so it’s a good idea to seek legal advice.

There are two things about gifts to be aware of when passing on property:

  • Seven-year rule. You can make an outright gift of your home to someone, no matter what it's worth, and it will be exempt from Inheritance Tax if you live for seven years after making the gift. This is known as a potentiallyexempt transfer (PET).
  • Gifts that you continue to benefit from. If you give your home to your children with conditions attached to it, or if you continue to benefit from the home yourself, this is known as a ‘gift with reservation of benefit’ and the gift won't be exempt from Inheritance Tax, even if you live for seven years afterwards.

Giving your home away and moving out of it

You can make social visits and stay for short periods in the home you give away, but there are guidelines as to how frequent the visits can be without the home becoming a ‘gift with reservation of benefit’.

Giving your home away and continuing to live in it

You can continue to live in your home as your primary residence after giving it away, provided you pay a market rent to the new owner. Bear in mind that the new owner may have to pay Income Tax on the rent you pay them.

If you don’t pay a market rent, the gift will be considered a ‘gift with reservation of benefit' and the house may be subject to Inheritance Tax.

Selling your home and giving the money to your children

If you sell your home and give the money to your children, the gift won't be included in your estate for Inheritance Tax purposes, provided you live for seven years after you make the gift.

However, if you sell your home, give the money to your children and then move into their home - whether this is into a granny annex they've made for you with the money or a room in a house they have purchased - there could be Income Tax implications as you may be classed as living in a pre-owned asset if you don’t pay the market rent.

If both you and your children sell your homes, pool your money and buy a new home as joint owners to live in together, the part belonging to you will be considered part of your estate for Inheritance Tax purposes.

If you don’t make equal contributions to the purchase, or don’t occupy the same share of the property as you purchased, you may have to pay Income Tax as your share may be classed as a pre-owned asset.

  • If you give your home to your children and they move in with you
  • If you give your home to your children and they move in with you, the gift will be treated as a ‘gift with reservation of benefit’ and the home will still be subject to Inheritance Tax.

However, if you give half of your home to your children, they move in with you and you share bills jointly, the half that you give them won't be treated as part of your estate for Inheritance Tax purposes as long as you live for seven years after making the gift.

Capital Gains Tax on a home you give away

As long as the home you give away is your main home, Capital Gains Tax won't be payable.

However, if you give away a second home, Capital Gains Tax may be payable if the property has increased in value between when you first owned it and when you gave it away.

The person you give the home to may also have to pay Capital Gains Tax if they make a profit when they sell, give away or exchange - 'dispose of' - the home, unless it's their main home.

Ways of owning property

There are different legal ways that you can own your home in England, Wales and Northern Ireland:

  • Sole tenancy - you personally own the home 100 per cent
  • Joint tenancy - you own the home jointly with someone else (usually a spouse, partner or child)
  • Tenants in common - you own a property with one or more people and each tenant is free to give away their share of the property as they see fit

The law is different in Scotland.

Leaving your home in your will

If you and your spouse or civil partner own your home as joint tenants, the surviving spouse or civil partner will automatically inherit the home and there will be no Inheritance Tax to pay on the property when the first partner dies.

If you own a property as tenants in common with another person, you each own a portion of the property. You can pass your portion on to your children when you die. Dividing your property between your spouse and grown-up children in this way reduces the future size of the taxable estate when your surviving spouse dies.

It is a good idea to discuss the implications of changing the way you own your home(s) with a solicitor if your estate is worth more than the Inheritance Tax threshold.

Business, Woodland, Heritage and Farm Relief

If you think your estate might be worth more than the Inheritance Tax threshold when you die - £312,000 for the 2008-09 tax year - there are some reliefs you can use to reduce your Inheritance Tax bill.

Business Relief

Business Relief allows you to pass on some of the business assets in your estate free of Inheritance Tax. You can pass these assets on while you’re still alive or as part of your will.

You can claim relief on property and buildings, or assets such as unlisted shares or machinery. Depending on the type of asset, they’ll qualify for relief of either 50 or 100 per cent.

Agricultural Relief

If you own agricultural property and it's part of a working farm, you can pass on some of your property free of Inheritance Tax in your will or before you die.

You can claim relief for farm property such as farmland. You can also claim relief for farm buildings if the size of the buildings is proportionate to the size of the farming activity. Relief is not available for farm equipment but it may qualify for Business Relief as a business asset.

Depending on the type of property, it will normally qualify for relief of 100 per cent. However, property rented out since before 1 September 1995 usually only qualifies for relief of 50 per cent.

Woodland Relief

When you die, the beneficiaries of your woodland can ask that the value of the timber - but not the land - be excluded from your estate. However, when the timber is sold, the beneficiaries may have to pay Inheritance Tax on the value of the sale unless it also qualifies for relief.

If the woodland qualifies for Agricultural Relief, Woodland Relief may not be available and you should claim Agricultural Relief instead. Business Relief may be available on woodland that qualifies as a business asset.

Relief for National Heritage assets

If you own a property such as a stately home or a famous and important work of art, these may qualify for relief from Inheritance Tax under certain very strict and exceptional conditions. The assets must also be made available to the general public to view.

Information about tax-exempt assets available for viewing by the public is held on a database of tax-exempt heritage assets.

The rules about what qualifies for this relief are very complicated. If you think you own National Heritage assets and want to claim relief for them, you can contact the HM Revenue & Customs Heritage Team on Tel 0115 974 2514 for further guidance.

Trusts: the basics

A trust requires a person called a ‘trustee’ to deal with certain assets in a particular way for the benefit of one or more beneficiaries. This article looks at some of the reasons why people have trusts and who is involved in setting them up and running them.

A trust is an obligation binding a trustee (which can be an individual or a company) to deal with assets - such as land, money, shares or even antiques - for the benefit of one or more ‘beneficiaries’. The people who run the trust, and in certain circumstances make decisions about how the assets in the trust are to be used, are known as ‘trustees’.

Trustees carry out the wishes of the person who has put assets into the trust. This person is known as the ‘settlor’. The settlor’s intentions for the trust are usually expressed in a legal document called a ‘trust deed’ or in their will.

The purpose of a trust - UK family trusts may offer a means for people to pass their wealth on to other people they have chosen. As such, they may be used to control and protect family assets.

If a will establishes a trust, this may allow people to pass on their assets in accordance with their wishes when they die.

A trust might be created in various circumstances:

  • When someone is too young to handle their affairs
  • When someone can't handle their affairs because they are incapacitated
  • To pass on money or property while you are still alive
  • Under the terms of a will - referred to as a ‘will trust’
  • According to the rules of intestacy, when someone dies without leaving a will (England and Wales only)

Trusts created by a will or intestacy are often referred to as ‘continuing trusts’.

Please note: there are other types of ‘non-family’ trusts. These are set up for a variety of reasons - for example to operate as a charity, or to provide a means for employers to create a pension scheme for their staff.

‘Trust property’ is a phrase commonly used for the assets held in a trust. It can include:

  • Money
  • Investments
  • Land or buildings
  • Other assets, such as paintings, furniture or jewellery, sometimes referred to as ‘chattels’

The cash and investments held in a trust are also called the 'capital' or 'fund' of the trust. This capital or fund may produce income, such as interest or dividends. The land and buildings may produce rental income. The way income is taxed depends on the type of income and the type of trust.

Trustees are the legal owners of the property held in a trust. Their role is to:

  • Deal with trust property in accordance with the trust deed
  • Administer the trust on a day-to-day basis and pay any tax due on the income or chargeable gains of the trust
  • In certain circumstances decide where to invest the trust's assets and/or how the property in the trust is to be used - although this must always be in accordance with the trust deed

The trust can continue even though the trustees might change. However, there must normally be at least one trustee. Often there will be a minimum of two trustees, one trustee may be a professional familiar with trusts - a lawyer, for example - while the other may be a family member or relative.

A beneficiary is anyone who benefits from the property held in the trust. There can be one or more beneficiaries, such as a whole family or a defined group of people, and each may benefit from the trust in a different way.

For example, a beneficiary may benefit from:

  • The income only - for example, they may receive rental income from a house or flat held in a trust
  • The capital only - for example, they may become entitled to shares held on trust when they reach a certain age
  • Both the income and capital of the trust

A settlor is a person who has put property into the trust. This is often referred to as ‘settling’ property. Property is normally put into the trust when it is created, but it can also be added at a later date. The settlor sets out in the trust deed how the property in the trust and any income received from the trust property should be used.

In some trusts, the settlor can also benefit from the property he or she has put in. These types of trust are known as ‘settlor-interested’ trusts and they have their own tax rules.

Differences between England and Scotland

When it comes to trust law and the terminology that is used in relation to trusts, there are differences between the law of England and Wales and that of Scotland. However, the tax treatment of trusts is the same throughout the UK. The advice given on these pages, therefore, applies equally to England and Wales, Scotland and Northern Ireland. If you need to know more about the legal differences, it is best to talk to your solicitor.

Get professional help for your trust

Understanding tax on trusts can be difficult. You might like to get professional advice from a tax adviser or solicitor to help you. However, if you do, remember that the trustees are still all legally responsible for ensuring that the trust’s tax affairs are carried out satisfactorily.

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