A guide to tax on inheritance and gifts

With planning and assistance, the burden of IHT can be avoided and allow you to gift assets and cash during your lifetime IHT efficiently. 

Our guide to tax on inheritance will provide you with an insight as to how and when IHT needs to be assessed, and what exemptions can be utilised. 

What is inheritance tax? 

IHT is assessable on individuals during lifetime when they transfer value out of their estate and when they die.

Upon death, an individual is assessed to IHT based on the value they own in their net estate. A net estate is calculated to be assets owned, less any outstanding liabilities. For example: 

Assets:

• Residential and commercial properties, and land
• Money
• Business assets and partnership interests
• Household and personal goods, for example, antiques, jewellery, furniture
• Stocks and shares – listed or unlisted
• Vehicles, boats or aircraft

Liabilities:

• Outstanding mortgage or loans due
• Credit card or outstanding bills
• Funeral expenses

An individual will also need to consider IHT during their lifetime where they make a chargeable lifetime transfer (CLT). Effectively, this is a ‘gift tax’ that is being applied on events such as a gift to a trust. From this point, the trust will then generally be assessable to IHT in its own right.

Inheritance tax rates

Upon death, inheritance tax is charged at 40% on the value held in an individual’s estate exceeding their available IHT thresholds. A lower rate of 36% can be applied where more than 10% of an individual’s estate is gifted to charity, which tax planning can assist with.

Should IHT become payable during lifetime as a result of a CLT being made, IHT of 20% will apply, after deducting any available exemptions and IHT threshold (nil rate band). More information about the nil rate band is provided below.

Inheritance tax exemptions and reliefs

Starting with exemptions, there are several options that can be made use of during lifetime and on death.

If you are an individual whose home is in the UK, any gifts you make to your spouse or civil partner is completely outside the scope of IHT and is classified as an exempt transfer. There is no monetary limit on this exemption, provided your spouse is UK domiciled, and applies during lifetime and on death.

This exemption also extends to gifts made to charities registered in the UK and a country in the European Economic Area (EEA), charitable UK trusts and other bodies such as political parties, housing associations or national heritage bodies.

You can also make use of a small gift exemption of up to £250 each year from one person to another. This can be a lifetime exemption and is an ‘all or nothing’ claim and there is no maximum amount of individuals it can be used for.

Everyone wants to be generous to a newly married couple, therefore an exemption for gifts on marriage is available. The exemption will depend on the relationship, for example, a mother and father can gift up to £5,000, grandparents can gift £2,500 and £1,000 for anyone else. This applies per marriage/civil partnership.

There is also an ‘annual exemption’ of £3,000 each year an individual can make use of for lifetime gifts. A parent could therefore gift up to £3,000 each year to their children. The added extra with this exemption is that if it is not used in one tax year, this can be carried forward to the next tax year. However, this carry forward rule can only apply for one previous tax year and can’t be cumulated over a number of years.

The final exemption available is called ’normal expenditure out of income’. This is slightly different to the others as there is no monetary limit and varies from person to person. A gift that constitutes as “normal” or typical will be exempt from IHT provided it doesn’t affect their standard of living. This is a very personal exemption and therefore each individual needs to be comfortable that certain gifts are meeting this definition.

In terms of reliefs, there are two different types of assets that will attract IHT relief at either 100% or 50%. These are known as Agricultural Property Relief (APR) and Business Property Relief (BPR). The value of assets attracting these reliefs will not be subject to IHT if the necessary conditions are met.

Inheritance tax threshold

Once all the assets and liabilities of the estate have been collated, you can consider what IHT exemptions and reliefs can be claimed (as above). At this point you will deduct the IHT tax threshold available.

All individuals are entitled to an IHT threshold, known as a nil rate band (NRB) of £325,000. This threshold can be used on death and during their lifetime. During lifetime, this threshold is refreshed every seven years.

The NRB was originally introduced into legislation from 1986 and the threshold started at 1986, since this date it has gradually increased until being levied at £325,00 from 6th April 2009. This is proposed to remain until 5th April 2028.

Individuals also need to consider whether they are able to utilise a further threshold known as the residence nil rate band (RNRB), which is currently set at £175,000. This is available where an individual leaves their home to lineal descendants, such as children, grandchildren, parents and spouses/civil partners of such descendants. A restriction of the RNRB is applied where the value in the individual’s estate is more than £2.35m.

One individual could therefore have £500,000 of thresholds to deduct against their estate before being subject to IHT at 40%.

These two thresholds (NRB and RNRB) can also be transferred to a surviving spouse where upon the death of the first spouse all the assets were transferred to the surviving spouse.  However, a restriction is applied to transferring the RNRB where the value of what would have been a couple’s total estate is more than £2.7m.

In effect an individual could therefore have £1m of thresholds to deduct against their estate before being subject to IHT at 40%.

When do you pay inheritance tax?

If the value of your estate is more than your available IHT reliefs, exemptions and thresholds, IHT must be paid to HM Revenue & Customs (HMRC) by the end of the sixth month following the date of death. For example, a person passes away on 16th January, any IHT would need to be paid by 31st July of that year. If IHT is paid late, HMRC will charge interest on the outstanding balance.

From an IHT administrative perspective, executors will have one year to file any IHT forms.

Paying an outstanding IHT liability by instalments is available where an estate holds assets such as land and property, a share in a partnership or business and certain types of shareholdings. This can help estates where they are asset rich and cash poor. These instalments are payable over 10 years and interest will accrue on the balance each year.

However, if the asset on which instalments has been claimed is sold, the outstanding IHT and interest will need to be paid to HMRC at the date of sale.

Finally, should any IHT become payable during lifetime, as a result of making a CLT (such as a gift to trust), IHT will need to be paid by the end of the sixth month following the gift, the same deadline as on death.

Tax on gifts given prior to death – what is the seven-year rule in inheritance?

If an individual makes a gift seven years before passing away, the value of these gifts will need be included in their estate, this is because the gift has failed for IHT purposes. There are two types of failed gifts that need to be taken into consideration:

• Chargeable lifetime transfers
• Potentially exempt transfers (PETs)

Where a CLT is made during lifetime, this is subject to IHT at the lifetime rate of 20%. IHT will be payable if the value of the gift exceeds the annual exemption and the available NRB. If the individual dies within seven years of having made the gift, the value of the CLT will be included as a deduction against the NRB, reducing the £325,000 available.

Gifts between individuals that are not covered by any exemptions are called PETs. PETs are not subject to IHT during lifetime. However, like a CLT, if the donor dies within seven years the value of these gifts will be a deduction against the NRB.

If any IHT becomes payable as a result of the failed gifts, taper relief can be utilised to reduce the 40% tax charge. Taper relief will only be available where more than three years have passed since the date of gift. As a result, IHT is reduced by 8% each year from the date of gift. Please see the table below for a breakdown of what relief is available:  

Years between gift and death	Taper relief available	Rate of IHT payable on gift
0-3 years	0%	40%
3-4 years	20%	32%
4-5 years	30%	24%
5-6 years	60%	16%
6-7 years	80%	8%

Some individuals may gift away assets with high value to family members to try to escape an IHT charge. However, in order for this to qualify as a PET, there must be a genuine no strings attached gift. This means the donor must not be able to benefit from the asset as they did before when they owned the asset. If a genuine gift did not take place, the ‘gifts with reservation of benefits’ (GWROB) rules will apply. If the GWROB rules apply, the value of the asset will still remain the estate of the individual on death.

For example, a mother transfers her main home to her two children, but continues to live in the property as she did before. In this case GWROB will apply. However, this can be mitigated if mother pays market value rent for using the property as a tenant would normally do.

In circumstances where GWROB does not apply, HMRC can use other anti-avoidance tax provisions, such as the Pre-owned Assets rules, which can lead to an income tax charge being levied on the donor in some circumstances where they benefit from assets which they have given away.

What is the most you can gift someone tax free?

There are a number of exemptions that can be made use of during lifetime, and these should all the used where possible.

The main £3,000 annual exemption is the starting point. As highlighted, this is available each tax year and any unused amount is carried forward to the next tax year. This carry forward facility is only available for one tax year only and therefore any unused amounts will be wasted. The exemption applies in chronological order, so gifts made first will be set against the £3,000 first.

This exemption can also be used alongside other exemptions, as an example the marriage allowance. For example, a parent could make use of their current year annual exemption of £3,000 along with the £5,000 gift on marriage exemption.

Hypothetically the following gifts could be made without being assessable to IHT (please refer to the ‘Inheritance tax exemptions and reliefs’ section):

• Any number of gifts made to a UK domiciled spouse/civil partner during the year without monetary limit.
• Gift cash of £250 to each grandchild on their birthdays each year.
• Charitable donations.
• The purchase of a £5,000 gift voucher for a daughter for her wedding day.
• Purchasing gifts worth up to £3,000 to all family members for those special occasions during the year.
• Making gifts out of income whilst maintaining your standard of living.

The normal expenditure out of income rules should be explored on an individual basis and made the most of.

Gifts made between individuals which do not exceed or meet the available IHT exemptions, will be classified as a PET. During lifetime a PET will be exempt from IHT and fully exempt provided the donor survives seven years. However, a PET will become chargeable if the donor does not survive seven years from the date of gift. Therefore making gifts early will assist with IHT planning.

Making IHT less daunting

The key to making IHT planning effectively is thinking about it and enacting it in good time. Many people bury their heads in the sand but thinking about it early will take the stress out of it and provide you with the reassurance that your loved ones will be looked after.

TaxAssist Accountants can help you plan your estate and provide you with bespoke tax advice and financial planning to put the necessary steps in place. Click here to contact us today.

Date published 10 Feb 2023 | Last updated 20 Mar 2024

This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayer’s circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.