How is UK inheritance tax calculated?

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This is more complicated that most people believe. It is based on the value of the estate of a deceased person at the time of death less available allowances plus value of any direct gifts or gifts into trusts over £3000 in value gifted in the previous 7 years. Allowance are usually a Nil Rate Band of £325,000 and a residential Nil rate band of £175,000 if a person owns or has owned a UK home.(This can be reduced for estates over £2 million). However if large gifts of over the NRB have been made in the 7 years before death taper relief (a reduction in the tax payable) is applied

Let’s start with a single person or divorced person, when they die the taxes immediately payable are dependent upon the value of their assets now. If the total value of their worldwide assets exceed £325,000, then tax is payable because the first £325,000 is a Nil Rate Band allowance which isn't taxable. If you own a main residence, which passes to immediate descendants, children, grandchildren adopted children, then you get a further allowance of £175,000 called the Residential Nil Rate Band. So when you add both of those together, you get a total allowance of £500,000 that is nontaxable. Everything else is taxable at 40%.

However, in addition you get allowances of £3,000 per year that you can make as gifts. If when you die, you have not used your allowances your solicitors (who are helping you with probate) should pay in the £3,000 for that year and possibly also the £3,000 pounds for the previous year. So, you can get an extra £6,000 if you've not made gifts during the last two years.

There's also the anomaly that if you've made gifts in the previous seven years directly, those gifts are brought back into your estate when you die and those will be regarded as Potentially Exempt Transfers. But if you've made gifts that exceed the nil rate band of £325,000, after four years you will get something called Taper Relief.

If you look on our website, there is a good calculator which helps work that out your inheritance tax and also does the projection.

If there's a married couple, if they leave their allowances to the surviving spouse, then there would be no tax to pay on first death and then the surviving spouse can claim those allowances, as well as their own, in the future.

There is something that one can do to significantly save some inheritance tax if there's likely to be a big gap between husband and wife dying. This is by taking the value of the property (£325,000) and  dropping it into a trust on first death. Now why would you do that? The reason is; the allowance is frozen until 2026, so by putting £325,000 into a trust the growth on that property value then grows outside of the surviving spouses estate. And as an example, if you say a property grows at about 3.5% a year so; £325,000 x 3.5% = £11,440 not in the surviving spouses estate, which means the saving on that is about £4,550 per year.

So for every year there is a gap between husband and wife dying there is a potential saving of £4,500. There is also an additional reduction in the value of the main residence for inheritance tax purposes on the second death of 10% to 15%. Part of the property is in trust on the one hand and the surviving spouse on the other. Because two separate legal entities own that property, the value in the surviving spouses estate is reduced by 10% for IHT calculation purposes.

If you want to understand how this works in more detail, please call and talk to us.

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