What is inheritance tax?
We provide a short guide on how Inheritance tax (IHT) is charged on gifts and other transfers of cash or assets that you make. Assets are things you own such as your house, shares or other possessions. There are some gifts that are free from IHT and we will also look at them here. We only cover the position for individuals who are domiciled in the UK.
What is IHT, briefly?
Inheritance tax (IHT) is basically a tax on the transfer of assets (either real ‘things’, property, savings and so forth) that you build up during your lifetime and then pass on to others. The passing to others might be during your lifetime, as a gift, or when you die. The tax is charged on the value of those assets less the value of anything you owe (mortgages, loans and so forth – although there are some restrictions on deducting these).
On this page we cover IHT on lifetime gifts and other basics of IHT.
If you own very many assets – often the most valuable of which might be your own home – it is useful to understand what IHT is and whether it will affect you if you make a gift now or whether any tax will be due on your estate when you die.
When someone dies, IHT might be payable on an estate if the value of the estate, together with any lifetime gifts that are or become chargeable on the death, is more than £325,000 (the ‘nil rate band’) plus, if their spouse or civil partner predeceased them and their taxable estate on death did not use up the whole of their nil rate band, the unused portion of the nil-rate band of the deceased spouse or civil partner. From 6 April 2017, this figure might be more if the estate includes a residence or former residence, or a residence was sold by the deceased prior to death, due to the ‘residence nil rate band’.
This short guide gives an overview only, so you might need to take further advice from a professional adviser. You can find a tax adviser on the Chartered Institute of Taxation website.
There are separate pages for IHT in relation to death estates.
Are any gifts free from IHT?
If any gift is free of IHT on death it will not be included in your estate when working out whether any tax is due. When you die, your estate is the total of your assets valued at the date of death less any amounts you owe (such as mortgages and loans) and certain expenses such as funeral expenses.
Important note: A gift free of IHT is not necessarily a gift free of capital gains tax(CGT).
Small gifts to the same person
You can make outright gifts of up to £250 in value to any one person in a tax year. The total gifts to any particular individual must not be more than £250 in that year.
You cannot combine this exemption with any other exemption for lifetime gifts, such as a gift on marriage.
Annual Exemption of £3,000
You can make gifts of up to £3,000 in total in any tax year and these are exempt from IHT. It does not matter how many people you make gifts to but the overall limit is £3,000.
A husband and wife (and civil partners) each have their own £3,000 exemption.
If you have not used your allowance of £3,000 for the previous year you can use that as well, but only after you have used the later year's exemption in full.
Gifts in consideration of marriage or registration of a civil partnership
You can give wedding or civil partnership gifts free of IHT of the following amounts:
- Up to £5,000 to each of your children, stepchildren or adopted children or their intended husband or wife (or civil partner);
- Up to £2,500 to each grandchild or their intended husband or wife (or civil partner);
- Up to £1,000 to anyone else.
Normal expenditure out of income
Gifts that are part of your pattern of normal expenditure can be free of IHT, but you must be able to make the transfer out of your income (after tax) without reducing your standard of living. For example, Christmas presents might fall into this category, or for instance you might decide to putn amount out of your surplus income into a savings account for a grandchild.
You might need to use some of your capital to help with the maintenance of your husband or wife (or civil partner), ex-spouse or former civil partner, children under 18 or in full-time education or a dependent relative. Such transfers are IHT-free.
Jack and Chloe – lifetime gifts and whether taxable
Jack and Chloe have been married for 40 years and have a son, two married daughters and five grandchildren. During 2016/17 they made no gifts at all but during 2017/18 Jack gives each of his grandchildren a gift of £250. Chloe gives £5,000 to their son as a wedding present and a further £5,000 to help in setting up his new house. Jack gives his disabled sister £4,000 to help with her nursing home costs. He also gives £1,000 out of his income every year to his brother.
None of these gifts are taxable:
- Jack's gifts to each of his grandchildren were within the £250 limit for small gifts and are tax-free.
- Chloe's wedding present to her son is also tax-free.
- Chloe has also used up her 2017/18 annual allowance of £3,000, together with £2,000 which she did not use during 2016/17 in making the extra gift to her son of £5,000.
- Jack's gift to his sister is exempt as family maintenance.
- Jack's gift to his brother is normal expenditure out of income. Alternatively it could use up £1,000 of his 2017/18 £3,000 annual allowance.
Gifts to your spouse or civil partner
If you make a gift to your spouse or civil partner, this is free from IHT, provided that they are UK-domiciled. In this context UK-domiciled normally means that the spouse or civil partner was born in the UK and is a citizen here – check with HM Revenue & Customs (HMRC) if you are unsure. There is more information on domicile in our migrants section.
If a spouse or civil partner is not UK-domiciled the limit for exempt gifts between spouses or civil partners is different. Up to 5 April 2013, there was a limit of £55,000 on the amount that could be transferred IHT-free to a non-domiciled spouse. From 6 April 2013, this limit is set at the level of the prevailing nil rate band (currently £325,000).
This exemption does not cover gifts you make to your unmarried partner or a partner that you are not in a registered civil partnership with.
Gifts to charities
You can make IHT-free gifts to most UK charities or to registered community amateur sports clubs whether outright or in the form of a trust. This exemption also covers qualifying charities established in the EU and some other countries.
Gifts to political parties
You can make an IHT-free gift to any UK political party as long as it has either at least two MPs in the House of Commons or one MP and received at least 150,000 votes in the last general election.
What rate of IHT will be I paid on my gifts?
If gifts you make are not free of IHT due to any exemptions, then a potential charge to IHT arises (see below).
For 2017/18, the rate of tax on gifts made during your life is 20% as opposed to 40% on death, but the first £325,000 of chargeable lifetime gifts or estate on death is charged at a nil rate (the ‘nil-rate band’). This 20% rate only applies, however, if there is an IHT charge arising during your lifetime – a chargeable lifetime transfer (see more under the next heading). If a lifetime gift is subsequently brought into your estate on your death, the 40% tax rate applies. But if you have made gifts above the value of your nil rate band, taper relief might be applied to those gifts if they were made three to seven years before death.
A lower rate of 36% may apply on death if more than 10% of the taxable estate above the nil-rate band is left to charity. See GOV.UK for more information on this.
You do not need to take account of any gifts you make that are tax-free. Check here for lifetime tax free gifts.
Most other non tax-free gifts you make, apart from gifts to certain kinds of trust, will be what we call potentially exempt transfers (PETs).
This type of gift will become completely free from IHT if you live for seven years, after the date you made it. If you die within seven years the gift becomes chargeable to IHT.
You do not need to notify HMRC about any PET when you make it and there will be no tax to pay at the time you make the gift. Over the years you need to keep a record, in date order, of all the PETs that you make, until the seventh anniversary of each gift, when you should take them out of your list.
If you make a lifetime gift into some types of trust, the gift will be a chargeable lifetime transfer (CLT). You may have to pay IHT at the time of making the CLT, if its value is more than the IHT threshold (£325,000 in 2017/18). This section does not consider CLTs. There is more information on the GOV.UK website.
How do I work out the IHT due on a lifetime gift?
For IHT there is a tax threshold, known as the nil rate band, and below this limit you pay no tax as the rate is set at 0%. For 2017/18 the threshold is £325,000.
If you die within seven years of having made a gift, and your total transfers to date that are still taxable are less than £325,000, there will be no more tax to pay on any PET that has not reached its seventh anniversary. This is because although the gift is taxable, the rate of tax is only 0%. However the PET is still added to your estate and so it does affect the amount of IHT paid on your death estate.
If you die within seven years of making a gift, and all your transfers to date that are still potentially exempt, because they have not reached the seventh anniversary, are more than £325,000, your executors will have some IHT to pay. They can, however, use any annual or other exemptions against each gift first, based on what you had available at the date of the original gift.
You look at the earliest gift first and then add on any later gifts in time order so that only the latest gifts that are over the £325,000 limit are taxed. You can see how this works in the example of Molly below.
Any tax that is then due can be reduced if the taxable gift was made more than three years before the date of death. This relief is called taper relief.
The longer the time since the gift was made the less tax you pay. The relief reduces the tax due by 20% per year, from 80% in the period of three to four years before the death to 20% when the gift was made between six and seven years before the death.
Example – Molly
Molly made no gifts until 5 April 2008 and then she gave away the following to her family. Each of the gifts was a PET at the time it was made:
To Kath, Molly's daughter – a picture valued at £10,000 on 5 April 2008
To John, Molly's nephew – cash of £16,000 on 5 April 2011
To Jenny, Molly's granddaughter – an antique clock valued at £9,000 on 5 April 2012
To David, Molly's husband – some land valued at £150,000 on 5 April 2013
To Brian, Molly's brother – some BT shares valued at £70,000 on 5 April 2015
Molly died on 6 April 2017. Her total estate excluding the above gifts came to £82,500.
The gift on 5 April 2008 is not taken into account as it was made more than seven years before Molly died.
The gift to husband David is tax-free.
The gifts to John and Jenny of £16,000 and £9,000 respectively are now taxable, but are also subject to annual exemptions. In the case of the gift to John, as no gifts were made in the previous year two annual exemptions may be used reducing the value of the gift to £10,000. In the case of the gift to Jenny, one annual exemption may be used, reducing the value of the gift to £6,000. The total value of the gifts to be taken into account for these two gifts is therefore £16,000, butstill below the nil rate threshold of £325,000.
The amount of the threshold remaining is £309,000 (£325,000 less £16,000).
This is set against the gift to Brian and then Molly’s estate.
The gift to Brian is not eligible for any taper relief as it has not passed its third anniversary. However it will be possible to take off the annual exemption of £3,000 for the year to 5 April 2015 and £3,000 for the previous year to 5 April 2014 as these have not been used. This leaves only £64,000 of the gift taxable, to which is added Molly’s estate on death of £82,500, a total of £146,500 which again is well within the nil rate band.
Although the gifts to John and Jenny were made over three years before death, no taper relief is given because no tax is due on them.
How do I work out the IHT when someone dies?
If you give something away but then continue to use the asset or enjoy a benefit in it, you will be treated for IHT as if you had not made the gift in the first place. A good example of this is when you give away your house to your children – they live elsewhere because they have their own homes and you continue to occupy your home after you have given it away.
The gift only becomes a PET as described above when you stop having a benefit in it, so if you should die before this happens the full value of the gift will remain part of your estate.
With regard to the gift of your home, there are certain exceptions to this rule if there is an unforeseen change in your circumstances in that you become infirm and are unable to maintain yourself through either old age or illness for example. In addition your occupation of the house must be only what might be expected as provision for your care and maintenance by the donee (person you have given the property to). Bear in mind for this to apply the donee must be a relative.
Note, however, that the residence nil rate band, available from 6 April 2017, will mean that more people may be able to leave their family home on their death to their direct descendants free from IHT.
What is pre-owned assets tax (POAT)?
With effect from 2005/06 the government introduced a pre-owned assets tax (POAT) as an IHT anti-avoidance measure. It is an annual charge to income tax on benefits received by a former owner of property. It applies to individuals who continue to receive benefits from certain types of assets that they once owned after 17 March 1986 but have since given away.
The POAT aims to tackle schemes which try to get around the so-called 'gifts with reservation' (GWR) rules in IHT. The GWR rules prevent a person from reducing their taxable estate by giving away property while continuing to enjoy it, such as giving one's house to one's children then continuing to live there.
POAT applies to three types of assets:
- household and personal goods; and
- intangible property or cash, stocks and shares and insurance products.
If you either dispose of any such assets by making a gift (or sometimes by selling them), or you contribute towards the purchase of the asset in question and then continue to receive some benefit from it, you are potentially liable to the charge. The benefit may be occupation of the land, use or possession of the asset or the ability to receive income or capital from a trust or settlement holding intangible property.
The scope of the POAT is very wide; there are some exclusions and exemptions, but it can apply where a parent gives away a home (or part of it) to a child but continues to live there, perhaps being looked after by the child. It can therefore catch ordinary family financial planning arrangements, not carried out with the aim of avoiding IHT.
If the POAT applies, there are provisions setting out how to calculate the taxable benefit.
Since the POAT applies to ‘benefits’, if you are caught by the charge, you may have to pay income tax even though you do not actually receive any income.
Election for IHT
POAT is payable where the value of an asset exceeds, roughly, £100,000, and IHT does not begin to be payable until a person’s estate exceeds £325,000. It is advantageous for those whose estates are valued at between those figures to pay IHT instead of POAT when possible. In addition, the IHT in this case would be payable on death, while POAT is an annual tax on income while the taxable person is still living.
The POAT rules allow people caught by the rules to elect to pay IHT rather than POAT – the election is for the asset to be treated as subject to a reservation. The normal deadline for such an election is 31 January in the tax year immediately following the tax year in which the person first became subject to POAT. So, if the POAT first arises in 2017/18, the individual must make their election by 31 January 2019.
HMRC have discretion, however, to extend indefinitely the period allowed for making the election for IHT rather than POAT. There is guidance on this in HMRC's Inheritance Tax Manual, which you can find on their website. This means that if you have inadvertently been caught by the POAT rules and have only become aware of POAT after the normal deadline HMRC are likely to accept a late election.
If you want more detailed guidance, you can find this in the Inheritance Tax Manual on GOV.UK.
Each individual has their own nil rate band. This means that their estate is exempt from IHT up to a certain threshold – currently £325,000.
There is a relief for married couples and civil partners whereby it is possible for an unused nil rate band to be transferred from the late spouse or civil partner to their surviving spouse or civil partner. This applies where the second death occurs on or after 9 October 2007.
There is more information on the nil rate band and the rules for transferring an unused nil rate band in the separate page, ‘what is the nil rate band?’.
Note that from 6 April 2017, there is an additional residence nil rate band that applies where the deceased left a residence or former residence to direct descendants as part of their estate, or if they ‘downsized’ (for example, sold a property and moved into residential care, or moved to a smaller house) before they died.
Where can I find more information?
Your local authority might be able to direct you to sources of bereavement support. Find out what might be available by using the following websites:
- England or Wales – use the facility on GOV.UK
- Scotland – visit the Scottish Government website
- Northern Ireland – visit nidirect
You can find out where to get help from third party organisations in our ‘getting help section’.
There is more information on what to do when someone dies, including your spouse or civil partner, in the other pages in the ‘bereavement and tax section’.
There is more information on the importance of making a will in the section ‘tax and writing a will’.
For more information on IHT have a look at the section on the GOV.UK website.
If your circumstances are complex, or the estate you are dealing with is complex, you may prefer to seek professional advice. You can find a tax adviser on the Chartered Insitute of Taxation website.