One of the most important tasks in sorting out an estate is dealing with any inheritance tax due.
This involves valuing the estate for inheritance tax purpose, completing the inheritance tax forms detailing the amount of tax due after claiming any reliefs, submitting the same to HM Revenue and Customs and making payment of the tax due in a timely manner.
As a general rule, Inheritance tax is payable on a person’s estates where the net assets exceed the Inheritance Tax threshold (“the Nil Rate Band”) currently set at £325,000.
Inheritance Tax can also be due on lifetime gifts either to an individual or to trusts. Lifetime gifts made within 7 years of death which are not directly taxable themselves (as within the Nil Rate Band) can reduce the amount of the available Nil Rate Band on death.
What is the rate of tax?
Subject to various exemptions inheritance tax on death is charged at either 40% or 36% on the amount in the estate over the available Nil Rate Band. The exact rate of tax depends on the terms of the will.
One of the main exemptions is the spouse or civil partner exemption where assets can pass from spouses or civil partners without being subject to Inheritance tax. Married couples or couples in registered civil partnerships can now also make use of the transferable nil rate band. This means that on the second death the Personal Representatives can utilise any unused nil rate band from the first spouse or civil partner’s estate.
So, for example, if the first person to die leaves everything to their spouse or civil partner, there will be no inheritance tax to pay on their death because of the spouse exemption. Then on the survivor’s death, the personal representatives will be able to transfer the unused portion of the nil rate band to use against the survivor’s estate, so in this case the nil rate band would be effectively doubled from £325,000 to £650,000.
Any gifts made to a ‘qualifying’ charity – during lifetime or in the will – will be exempt from Inheritance Tax.
If the Will makes provision for 10% or more of the estate to pass to charity the 36% rate applies to the taxable element of the estate.
Business Property Relief
If the deceased owned and ran a business the value of the business may qualify for Business Property Relief (“BPR”).
The deceased’s share of a business run either as a sole trader or in a partnership will potentially qualify for 100% BPR as will shareholdings in private trading companies.
Shares in quoted trading companies will only qualify for 50% BPR in the event that the deceased owned 50% or more of the share capital. This is rare in practice.
Land and Buildings/machinery used by a company or partnership controlled by the donor may also qualify for 50% BPR.
To qualify for BPR at all however the following criteria must be met:
Relevant Business Property – the business must meet the definition in the Inheritance Tax Act 1984 of relevant business property. In short this means it must be wholly or mainly a trading business rather than an investment business. Sometimes the lines can be blurred as a property investment business is unlikely to qualify whilst a property maintenance business may well qualify.
Ownership period – the interest in the business must be owned for 2 years prior to death (unless replacement for another business owned for over that time frame);
Contract for Sale – there must be no binding contract for sale in place. Sometimes partnership agreements and shareholder agreements including the automatic right for the remaining partners or shareholders to buy the business from the deceased person. This counts as a binding contract for sale in which case BPR is denied. It is important to carefully check these provisions.
Excepted Assets – the availability of BPR may be limited if its assets includes large unallocated cash reserves or investments.
Agricultural Property Relief
If the deceased owned a farm relief may be available at either 50% or 100% depending upon whether it was tenanted or farm personally and subject to how long it has been owned for.
If farmed personally it must be owned for at least 2 years prior to death. If tenants it must be owned for 7 years prior to death.
50% relief is available where the land is tenanted and let on a lease since before September 1995 which has more than 2 years to run at the date of death.
In all other cases (subject to ownership periods) relief is available at 100%.
Woodland Relief and Heritage Relief
Owning a woodland may qualify for Business Property Relief or Agricultural Property Relief depending on the circumstances. If it does not then Woodland Relief may be available.
Unlike the other Reliefs detailed above woodland relief simply postpones the tax on the value of the trees. The value of the land is immediately chargeable to inheritance tax.
IHT becomes payable when the trees are sold at a later date. Any sale of the land and trees will also trigger an IHT charge.
Woodlands relief is also only available if the woodland has been owned for 5 years prior to death or has otherwise been inherited or received via gift rather than purchase.
Conditional Heritage Property Relief
Heritage property includes items of national, scientific, historical, architectural or artistic interest. Subject to various conditions IHT is not charged on heritage property but the relief is conditional upon the items not being sold and the new owner agreeing to allow reasonable public access and details of the property being publicised on HMRC’s website.
If the property is sold or public access withdrawn IHT becomes payable.
Who pays Inheritance Tax and when is it due?
Generally the Personal Representatives will pay the inheritance tax due on death from assets in the estate of the deceased. Occasionally where the deceased has made large gifts shortly before death, the person who has received the gift may have to pay a some inheritance tax.
Inheritance tax is due 6 months from the end of the month of the date of death. The Inheritance tax due on an estate generally needs to be paid before the Personal Representatives can obtain the grant of representation to administer the estate. A notable exception to this is where there is a Property in the estate. The proportion of inheritance tax due on property can be paid in ten yearly instalments (although if the property is sold within those ten years, the whole balance has to be paid when the sale completes).
Valuing an Estate for Inheritance Tax
If you are the Personal Representative of an estate, you have an obligation to correctly value the assets and liabilities in the estate at the date of death.
For example if there is a property in the estate you will generally need to obtain three market valuations at the date of death. These figures are used in the HM Revenue & Customs Inheritance Tax Account which must be competed in order to obtain a grant of probate. If the property later sells for less than estimated it may be possible to reclaim the tax paid.
Shares must be properly valued and regard must be had to the related property rules which can affect valuations of assets.
There are also various restrictions on the deductions of debts due from an estate.
Interest and Penalties
Any inheritance tax unpaid after the 6 months from the end of the month of death begins to attract interest.
Penalties apply to both the initial amount of inheritance tax and to any late instalments.
A 5% penalty applies on late paid tax, plus a further 5% penalty on tax still unpaid 5 months later and again 11 months later.
For second and later instalments the penalty is due where the tax is unpaid 30 days after the due date.
Any penalties may be payable by the executors personally rather than from the estate funds.
For advice and assistance in valuing the estate for inheritance tax purposes and ensuring the calculations and correct amount of tax are paid please contact us for an appointment.