Inheritance Tax (IHT)
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 £325,000 (2009-10 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 £325,000 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
Exempt beneficiaries
You can give things away to certain people and organisations without having to pay any Inheritance Tax. These gifts, which are exempt whether you make them during your lifetime or in your will, include gifts to:
- your husband, wife or civil partner, even if you're legally separated (but not if you've divorced or the civil partnership has dissolved), as long as you both have a permanent home in the UK
- UK charities
- some national institutions, including national museums, universities and the National Trust
- UK political parties
But, bear in mind that gifts to your unmarried partner or a partner with whom you've not formed a civil partnership aren't exempt.
Exempt gifts
Some gifts are exempt from Inheritance Tax because of the type of gift or the reason for making it. These include:
Wedding gifts/civil partnership ceremony gifts
Wedding or civil partnership ceremony gifts (to either of the couple) are exempt from Inheritance Tax up to certain amounts:
- parents can each give £5,000
- grandparents and other relatives can each give £2,500
- anyone else can give £1,000
You have to make the gift on or shortly before the date of the wedding or civil partnership ceremony. If it is called off and you still make the gift, 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 (6 April to the following 5 April) without them being liable for Inheritance Tax.
But you can't give a larger sum: £500, for example, and claim exemption for the first £250. And you can't use this exemption with any other exemption when giving to the same person. In other words, you can't combine a 'small gifts exemption' with a 'wedding/civil partnership ceremony gift exemption' and give one of your children £5,250 when they get married or form a civil partnership.
Annual exemption
You can give away £3,000 in each tax year without paying Inheritance Tax. You can carry forward all or any part of the £3,000 exemption you don't use to the next year but no further. This means you could give away up to £6,000 in any one year if you hadn't used any of your exemption from the year before.
You can't use your 'annual exemption' and your 'small gifts exemption' together to give someone £3,250. But you can use your ' annual exemption' with any other exemption, such as the ' wedding/civil partnership ceremony gift exemption'. So, if one of your children marries or forms a civil partnership you can give them £5,000 under the wedding/civil partnership gift exemption and £3,000 under the annual exemption - a total of £8,000.
Gifts that are part of your normal expenditure
Any gifts you make out of your after-tax income (but not your capital) are exempt from Inheritance Tax if they're part of your regular expenditure. This includes:
- monthly or other regular payments to someone, including gifts for Christmas, birthdays or wedding/civil partnership anniversaries
- regular premiums on a life insurance policy (for you or someone else)
It's a good idea to keep a record of your after-tax income and your normal expenditure, including gifts you make regularly. 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.
Maintenance gifts
You can also make Inheritance Tax-free maintenance payments to:
- your husband or wife
- 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
'Potentially exempt transfers'
If you, as an individual, make a gift in any of the situations described below and it isn't covered by one of the exemptions already described, it is known as a 'potentially exempt transfer' (PET). A PET is only free of Inheritance Tax if you live for seven years after you make the gift.
Gifts that count as a PET are gifts that you, as an individual, make to:
- another individual
- a trust for someone who is disabled
- a bereaved minor's trust where, as the beneficiary of an Interest In Possession (IIP) trust (with an immediate entitlement following the death of the person who set up the trust), you decide to give up the right to receive anything from that trust or that right comes to an end for any other reason during your lifetime - see example below
Example: a wife is the beneficiary of assets in an IIP trust under her husband's will and the minor child a beneficiary of income, but the wife decides to give up any interest in the assets and these also become held in trust for the bereaved minor child.
Changes introduced by the Finance Act 2006 mean that lifetime transfers into other types of trust since 22 March 2006 no longer qualify as PETs.
Only 'outright gifts' count as PETs
If you make a gift with strings attached (technically known as a 'gift with reservation of benefit'), it will still count as part of your estate, no matter how long you live after making it. For example, if you give your house to your children and carry on living there without paying them a full commercial rent, the value of your house will still be liable for Inheritance Tax.
In some circumstances a gift with strings attached might give rise to an Income Tax charge on the donor based on the value of the benefit they retain. In this case the donor can choose whether to pay the Income Tax or have the gift treated as a gift with reservation.