Inheritance tax is a complex matter that is subject to no small amount of misunderstanding among the general populace. The topic has always been somewhat controversial and occasionally even inflammatory, but as with all matters of taxation, an understanding of the basic fundamentals of what inheritance tax actually is vitally important. To try and introduce clarity to this all-too-complex matter, we have put together a simple, easy-to-understand guide to modern UK inheritance tax.
What is the inheritance tax?
This is a tax that is levied on an estate that has been inherited. For example, if Adult A passes away and bequeaths £1 million to their child, Child B. This would mean that Child B will be liable to pay tax on the inheritance.
How does the tax work?
In the example above, we stipulated that Child B would inherit £500,000 from Adult A, and that they would be required to pay inheritance tax on this sum. However, inheritance tax only applies above a certain threshold. The normal threshold is £325,000 – though, as we will discuss below, this can change. Continuing our example, this means that of the £1 million inheritance, Child B would pay tax on £675,000 – i.e. only on the amount of inheritance over the £325,000 threshold.
Is this tax always levied?
No, inheritance tax is not due if:
- The deceased bequeath their estate to their spouse or civil partner.
- The deceased bequeaths to a charity or an amateur sports club.
Any other beneficiaries of the estate – including children and other family members – must pay this tax.
What are the rates and limits of the tax?
- The basic rate of the tax is 40%. In the example we’ve used above, this would mean that Child B would pay £270,000.
- However, the threshold increases to £450,000 if the deceased person has given their home away to their children.
- A spouse or civil partner can ‘inherit’ the inheritance tax threshold of their spouse/civil partner. For example, if Mary and John are married and John dies without inheriting anything from anyone, Mary’s ‘inherits’ John’s threshold. This means Mary’s total threshold could be as high as £900,000.
- Inheritance tax can be reduced to 36% if 10% – or more – of the net value of assets in the estate are donated to charity.
- Returning to our example, if Adult A had donated £100,000 of their £1 million estate to charity, Child B would have inherited £900,000.
- They would only have to pay tax on £575,000 of this, thanks to the threshold.
- The tax rate would be 36% rather than the standard 40%, which means they would pay £207,000 in tax.
Other reductions and thresholds may be applicable. It’s a good idea to seek advice from a financial expert for further information on these.
What is the future of inheritance tax?
At present, the inheritance tax is incredibly lucrative for HMRC, with a 13% rise in the collection total in the last tax year. However, this tax is something of a political hot potato and is continually subject to much discussion and research as to potential changes. What people feel these changes should be varied across the political spectrum. For example, some people argue that inheritance tax should be abolished; others argue for a 100% tax. With such divergent views, it is fair to assume that the tax’s status will be debated for years to come – and that it is likely to continue to raise substantial funds for the exchequer in the meantime.
Having read through the above, you should hopefully have a strong idea of how inheritance tax actually operates. If you have any questions or concerns regarding inheritance tax, please do get in touch – our tax experts will be more than happy to advise you further.