When a person dies, their estate may be subject to payment of Inheritance Tax depending on the value of the estate and to whom the assets are left.

If the entire estate is left to the surviving spouse/civil partner or a registered charity, no Inheritance Tax (IHT) may be payable.

Principles

IHT is primarily a tax that takes effect on death. When a person dies, IHT is charged on the value of their estate, subject to various exemptions and reliefs. The value of the estate is broadly assets less liabilities.

It would appear therefore that the easy way to avoid liability for IHT would be to give as much away during one's lifetime. However, IHT is charged on certain lifetime gifts or transfers if the donor dies within seven years of making the gift.

Such a gift is called a potentially exempt transfer because at the time when the gift or transfer is made no IHT is chargeable. If the donor survives for seven years, no IHT is payable. If the donor dies within the period the IHT will be payable on the gift or transfer.

Liability for IHT on death

Who is liable for payment to Inland Revenue and who bears the responsibility for the payment are two separate issues.

HMRC are only concerned with payment of Inheritance Tax (IHT) and will look to those representing the estate, being the Personal Representatives (PRs) (those appointed to manage the estate) and trustees. Those who ultimately receive the property will be concurrently liable with the PRs but in practice, the tax has already been paid to HMRC before the beneficiary receives the property.

The PRs are liable to pay IHT on property that falls into the estate (property which passes under the deceased's will or intestacy (Dying without a will) - where someone dies without having made a valid will). They are also liable for the tax on property that does not pass to the estate but to which the deceased was entitled such as property passing to a joint owner by survivorship.

Where the deceased dies within seven years of making a lifetime gift, the PRs may need to pay IHT for that gift from the estate. The person who received the gift is primarily liable for the tax, but if IHT is not paid within twelve months after the end of the month in which the transferor died, HMRC will look to the PRs who then become liable. The PRs are liable to pay the IHT only to the value of the assets they received or would have received but for their negligence.

IHT burden on death

Inheritance Tax (IHT) on estate property is treated as part of the general testamentary and administration expenses.

In most cases, unless the will indicates an intention to the contrary, IHT is paid from the residuary estate, after payment of debts, expenses and any specific or cash gifts.

Where property passes outside the estate, the PRs still retain a responsibility to pay IHT but they have the right to recover the IHT from the person in whom the property vests, for example, the surviving joint tenant who acquired the property by virtue of having survived the deceased.

If a person is entitled to a life interest under a trust and the estate is liable to IHT in respect of the property, the burden of IHT falls on the trustees who are also liable to pay the tax and not the PRs.

How to calculate IHT on death

There are basically five steps involved in the calculation of IHT. They are the following:

• Identify the estate
• Value the estate
• Apply any relevant exemptions
• Apply any relevant reliefs
• Calculate tax at the appropriate rate

Identify the estate

A person's estate is the total of all the property to which they are entitled but certain property is excluded. An example of excluded property is a future interest which means that although the beneficiary may ultimately have an absolute interest in a property, during their lifetime another beneficiary is entitled to the use of the property.

Trust property

Where a person is entitled to claim income from a property in trust, they have an interest in possession in trust property. This occurs where a property is left in trust for one beneficiary or a number of beneficiaries but the income from the property is paid to another individual during their lifetime. That individual who receives the income is entitled to that income and on their death, the value of the property is included in their estate for tax purposes. Although the individual did not have control over the property on their death, the property is treated as part of their estate and tax will be payable out of the trust fund.

Property outside the estate

If the deceased took out a life assurance policy written in trust for a named beneficiary, the proceeds of the policy do not form part of their estate and therefore IHT will not be payable. The same principle applies to monies paid into a pension fund for the benefit of the deceased's family.

Two people dying simultaneously

If two people die together (for example, in an accident) and there is no evidence of the order of their deaths, the normal rule for the purpose of determining inheritance rights is that the younger is deemed to have survived the older.

There are exceptions to the normal rule. For example:

In England and Wales

The normal rule does not apply between spouses or civil partners if the older spouse/civil partner dies intestate. In this case, the presumption is that the younger spouse/civil partner did not survive the older. Further, the deceased's spouse/civil partner must outlive them by 28 days in order to benefit.

In Northern Ireland

If the order of death cannot be satisfactorily determined, neither person is deemed to have survived the other. This means that neither of their estates can benefit from the other.

Thus, where the normal rule applies, if the beneficiary is older than the testator, the gift will fail. If the beneficiary is younger than the testator the gift does not fail but falls into the beneficiary's estate.

For the purposes of IHT, however, the deaths are presumed to occur at the same instant. By way of example, John leaves property in his will to his younger brother James who in turn leaves the property to his children. If John and James die in a motor accident and it is not possible to establish the order of death, the property will pass from John to James and thereafter to James' children. For IHT purposes, the property left by John to James will be taxed as part of John's estate and not part of James' estate.

Value the estate

Assets in an estate for IHT purposes are valued at the open market value. It is 'the price which the property might reasonably be expected to fetch if sold in the open market'. Generally assets are not difficult to value but in the case of land, it may be necessary to negotiate a value with the district valuer. The value immediately before death of every asset forming part of the estate for IHT purposes must be assessed and reported to HMRC in the tax return.

Application of valuation principles

The value placed on bank and building society accounts is the balance as at the date of death including interest

The value of quoted shares is taken from the Stock Exchange Daily Official List for the date of death. To value the shares for IHT, take one quarter of the difference between the lower and higher price and add it to the lower price.

It is more difficult to value unquoted shares. The principle of the open market value will apply and information will be required about the company. Generally, this is obtained from the company accountants.

For land and buildings, it is relatively straightforward to reach a value where the deceased owns the entire property. As mentioned a value may have to be negotiated with the district valuer. Where the deceased owned a share of the property, the value of the whole property is taken and divided by the number of shares. A discount of 10-15% in the value of the property is normally allowed to reflect the fact that a part interest will be far more difficult to sell. The discount will not be permitted in the case of spouses or civil partners co-owning the property.

Specific valuation rules apply where the parties are related. Property owned by spouse/civil partners is worth more valued together than separately. Each spouse/civil partner's share of the property must be valued not in isolation but as a proportion of the whole. For example, a husband and wife each own 35% of the shares in a company and the husband dies. His share for IHT purpose is not valued as 35% of the company but half of 70% to reflect that a 70% shareholding will be worth more, as this gives control of the company.

Apply any relevant exemptions

We've included two of the more common exemptions below, but you should consult your solicitor or legal/tax adviser for advice on whether any others may apply.

Spouse/civil partner exemption

All property forming part of the estate for Inheritance Tax (IHT) passing to the deceased's spouse/civil partner either under the will or on intestacy is exempt. No IHT will be payable irrespective of the value of the assets. Where the deceased leaves his estate to trustees on trust to pay the income to his spouse/civil partner for life with the capital thereafter to his children, the spouse/civil partner exemption applies.

Charity exemption

Any property forming part of the deceased's estate which passes on death to charity is exempt from IHT. Gifts to certain national bodies, such as museums and art galleries or political parties also qualify for a similar exemption.

Apply any relevant reliefs

Nil-rate bands

These are the 'general nil-rate band' and the 'residence nil-rate band'.

General nil-rate band

In addition to the situations where gifts are tax-free, in your will you are allowed to make gifts up to a certain value to anyone you wish, free of tax. The allowed value, known as the general nil-rate band, is currently £325,000.

This general nil-rate band is not applied to your estate until after any gifts to your spouse/civil partner, UK charities, UK political parties and your burial expenses, together with other allowable deductions e.g. mortgages, have been deducted from the value of your estate.

If you make any relevant gifts (or other transfers of assets) during your lifetime, these may use up (and, therefore, reduce) the general nil-rate band available to your estate after you die.

Unused portions of the general nil-rate band can be transferred between spouses and civil partners. The amount of the general nil-rate band available on the death of the second spouse/civil partner to die is increased by the percentage of the general nil-rate band of the first partner to die which was not used on that first death. The percentage is calculated by taking the general nil-rate band in force on the first death and seeing how much of it, expressed as a percentage, was used up by the first spouse/civil partner on his or her death.

Example:

Husband (H) died in 2002/2003 when the general nil-rate band was £250,000. He left £125,000 to his son and the rest to his wife W. W dies in 2019/2020 when the general nil-rate band was £325,000. H only used 50% of his general nil-rate band. The general nil-rate band available on W's death is increased by 50%; i.e. to £487,500. If H had left everything to W, he would have used 0% of his general nil-rate band. The general nil-rate band available to W on her death would be increased by 100%; i.e. to £650,000.

It does not matter whether there were sufficient assets on the first death to utilise the general nil-rate band.

It is possible to acquire the general nil-rate bands of more than one deceased spouse/civil partner. However this only applies up to a limit of one additional general nil-rate band.

Example:

H1 dies leaving everything to his wife W. W thus acquires a 2nd general nil-rate band.

W marries H2.

W dies in 2010/11. W left £325,000 to her son and residue to H2. The general nil-rate band available on the death of H2 will be increased by 100% to £650,000.

If, instead, W left everything to H2, the general nil-rate band available on the death of H2 will still only be increased by 100% to £650,000. Half the double general nil-rate band of W (representing the general nil-rate band of H1) is wasted.

A claim must be made for this relief, normally by the executors of the second spouse/civil partner to die, within two years of the end of the month that the second spouse/civil partner died.

Residence nil-rate band

The residence nil-rate band ('RNRB') is in addition to the general nil-rate band and applies so that less IHT may be paid on an estate when the estate includes a 'qualifying residential interest' and that qualifying residential interest is inherited by a qualifying beneficiary.

What is a qualifying residential interest?

A qualifying residential interest is a house or a flat (or a share of a house or flat) owned by the deceased that forms part of their estate and which the deceased lived in at some stage before their death. They did not have to be living in the house or flat when they died.

If the estate includes more than one house or flat that the deceased has lived in, the executors will have to nominate which will be the qualifying residential interest.

Where the deceased has sold their house/flat and downsized to a less valuable property, or even if they no longer own a qualifying residential interest (or any share in one), their estate may be entitled to an additional amount of RNRB (a 'downsizing addition') if the deceased had a qualifying residential interest which they sold on or after 8 July 2015 and at least part of their estate is inherited by a qualifying beneficiary. Only one disposal can be taken into account for the downsizing addition; if there has been more than one, the deceased's executors can choose which one to use.

The amount of the downsizing addition will generally be equal to the RNRB that's been lost because the former qualifying residential interest is no longer in the deceased's estate, but it can't exceed the maximum amount of RNRB that would have been available if the disposal or downsizing hadn't happened.

A claim has to be made for a downsizing addition by the deceased's executors; this has to be done within 2 years of the end of the month that the deceased died.

Who is a qualifying beneficiary?

For the RNRB to be available, the qualifying residential interest must be inherited by any one or more of the following:

• a 'lineal descendant';
• someone who is a spouse or civil partner of a living lineal descendant at the time of the deceased's death; or
• someone who was a spouse or civil partner of a deceased lineal descendant ('surviving spouse or civil partner') at the time the lineal descendant dies if they died before the deceased and the surviving spouse or civil partner had not remarried or formed another civil partnership before the deceased's death.

A lineal descendant is a child, grandchild, their child and so on. For RNRB purposes, lineal descendants also include anyone who was, at any time:

• a step-child of the deceased;
• an adopted child of the deceased;
• a foster child of the deceased;
• a child that the deceased was a guardian or special guardian of provided that the appointment took effect when the child was under 18; or
• a lineal descendant of any of the above.

What does inherited mean?

The qualifying residential interest must become part of the qualifying beneficiary's estate for IHT purposes as a result of the deceased's death. The RNRB is not available for gifts by the deceased while they were alive. The general nil-rate band is, in contrast, available for such lifetime gifts.

Therefore, a qualifying beneficiary inherits the qualifying residential interest if it is given to them outright on the deceased's death as it is then part of the beneficiary's estate for all purposes. It can also be given on the deceased's death to certain forms of trust for their benefit under which it is treated as part of the beneficiary's estate for IHT purposes even though it is not part of the beneficiary's estate for other purposes.

How is the RNRB calculated?

The basic RNRB level (which can be added to the general nil-rate band to increase the amount of assets in the deceased's estate that will be taxed at 0%) is currently £175,000. It will continue at this level until the end of the 2027/28 tax year.

This 'default allowance' will be adjusted if the value of the deceased's estate is more than £2 million. For every £2 by which the value of the deceased's estate exceeds £2 million, the default allowance is reduced by £1. The resulting amount is the 'adjusted allowance'. If the deceased dies in the tax year 2023/24 and their estate is worth more than £2.35 million, the default allowance of £175,000 is withdrawn completely and, therefore, there will be no available RNRB.

The amount of the RNRB that is available to the deceased's estate is either the adjusted allowance or, if this is lower, the value of the qualifying residential interest that is inherited by qualifying beneficiaries.

Transfer of unused RNRB

Unused RNRB is transferable to a spouse/civil partner in much the same way that the general nil-rate band is, but the transfer regimes operate independently. This means that there may be unused RNRB, but no unused general nil-rate band (and vice versa) or the percentages unused in each case may be different. The executors of the second of the couple to die must make a claim to transfer the unused RNRB within 2 years of the end of the month that the second of the couple dies.

The RNRB may be unused if the first of the couple either did not have a qualifying residential interest or did have a qualifying residential interest but it was not inherited by qualifying beneficiaries.

RNRB can still be transferred even if the first of the couple died before RNRB was available (i.e. before 6 April 2017). In this case, the unused RNRB is treated as £100,000 and the unused percentage as 100%.

If the second of the couple to die has had more than one spouse or civil partner, a claim can be made to transfer unused RNRB from each one, but the total transferred cannot be more than the maximum RNRB available at the time of the death of the second of the couple to die.

Certain relief from IHT may also be granted in respect of the transfer of business and UK agricultural property both during the owner's lifetime and on death.

Business property relief

If the deceased owned business property for a period of two years or more prior to transfer, it may be eligible for tax relief.

Business property relief of 100% is available for a business or partnership share or unquoted shares (private company).

Business property relief of 50% is available in the case of quoted shares (provided the transferor had control of the company immediately prior to the transfer) and land, buildings, plant and machinery where the transferor was a partner or in control of the company.

For the purposes of calculating IHT the value of the property will be reduced by either 100% or 50%.

Agricultural property relief

Where the transferor occupied agricultural property throughout the two years prior to the transfer or he owned the agricultural property throughout the seven years immediately before the transfer, agricultural relief will apply.

Agricultural relief of 100% is available where the transferor had the right to vacant possession immediately before the transfer or let the land under a lease after 1 September 1995.

Agricultural relief of 50% is available on any other qualifying agricultural property

Calculate tax at the appropriate rate

The rates of tax applicable on death are currently:

• 0% on the first £325,000 (nil rate band).
• 0% on any amount that the RNRB is available for.
• 40% on the balance of the estate on death.

Cumulation

All assets must be taken into account before one is able to commence calculation of the IHT payable. This includes immediately chargeable lifetime transfers and potentially exempt transfers that have become chargeable as a result of the transferor dying within seven years of making the gift. The cumulative total will then be calculated.

The general nil-rate band is then applied to the first £325,000 and the balance of the estate, if any, will be chargeable to IHT at the rate of 40%.

The amount of any available RNRB is usually deducted from the value of the deceased's estate on death before the amount of the general nil-rate band. Except that, if the deceased made lifetime gifts on which IHT would otherwise be payable, the general nil-rate band is applied against those first, then the RNRB applied against the deceased's estate on death and then finally, if there is any balance remaining of the general nil-rate band that is applied against the value of the estate on death as reduced by the RNRB.

Estate rate

Estate rate means the average rate of tax applicable to each item. Sometimes it is important to work out how much tax is attributable to particular items of property. The PRs may be paying tax on the land by instalments or the PRs are not liable for all the tax as would be the case where a legacy is left to the beneficiary 'subject to tax'. The basic principle therefore is that the tax is divided between the various assets in the estate proportionately, according to their value.

Quick succession relief

If the deceased received property under a chargeable transfer made to them within five years before they died, relief is available to reduce the amount of tax payable. The amount of the reduction varies according to the number of years between the transfer and the death. The closer the transfer to the death, the greater is the reduction in tax payable.

Where the transfer was made in the year before death, the reduction is 100%, 1-2 years before death and it is 80%, down to 20% in years 4 and 5. Relief only applies where tax was paid on the transfer and tax is payable on the deceased's estate.

Time for payment

Non-instalment option property

The Inheritance Tax (IHT) payable on the property in the estate that does not attract the instalment option is due for payment six months after the end of the month of death. This is known as the due date. If payment is made thereafter HMRC will be entitled to interest on the amount outstanding.

At the same time as they deliver the tax return, the PRs must pay the IHT on the property which does not have the non-instalment option. The account must be delivered within twelve months of the end of the month of death. Without payment of the IHT, a grant cannot be obtained. In the circumstances, the PRs will usually submit the account and pay the IHT before the due date.

Instalment option property

If property in the estate qualifies for the instalment option, the PRs can elect to pay the IHT in respect of that property in ten equal yearly instalments. The first instalment is payable six months after the end of the month of death. Annual instalments are due each year thereafter, up to a maximum of ten years.

Property qualifies for the instalment option if it is:

• Land
• A business or interest in a business.
• Shares (quoted or unquoted) where the deceased had control of the company immediately prior to their death
• Unquoted shares which do not give control if either the holding is sufficiently large (10% of the nominal value of the shares and worth more than £20,000) or HMRC is satisfied that tax cannot be paid in one lump sum or IHT attributable to the shares or other instalment option property in the estate amounts to at least 20% of the IHT payable on the estate

Interest

Interest on the instalment option property comprising of land is payable with each instalment apart from the first, on the amount that was outstanding the previous year.