Chapter 4 – Inheritance Tax (8 or 9 marks!!)

Question 1

This chapter looks at the last of the four key ‘direct’ taxes (the others being income tax, national insurance, and capital gains tax). The term ‘direct’ tax indicates taxes that are imposed directly on the taxpayer; this contrasts to ‘indirect’ taxes which are paid as part of the price of goods or services.

Question 2

What is IHT?

Answer 2

A tax on the value of the person’s estate on death & on certain gifts made by an individual during their lifetime

Question 3

Tell me about the annual exemption for IHT?

Question 4

can the small gift exemption be used in conjunction with the annual exemption

Question 5

What exemptions to IHT are available In relation to marriage?

Question 6

Tell me about the exemption that applies to gifts made out of regular income?

Answer 6

It must be from regular income, NOT capital

…add more

Question 7

Some of the exemption are only allowed during the persons lifetime. Some are exempt in both lifetime and on death.

Tell me which this applies to specifically

Question 8

NOTE: IHT reliefs and IHT Exemptions are 2 different things

Question 9

In relation to IHT there is a limit to the inter-spouse exempt amount if the recipient of the transfer is non-UK domiciled. Why is this and what is the limit

Answer 9

Why: To avoid the potential of losing large assets to someone who cannot be caught easily in HMRCs net

What is the limit: £325,000 (same as nil rate band), meaning that £650,000 can be transferred with no IHT to pay.

remember: For domiciled spouses transfers between them are completely exempt

LOOK AT EXAMPLE 4.2

Question 10

Poetntially Exempt Transfers are transfers made by an individual to where:

Answer 10

Another individual
or
A bare trust
or
A disabled trust

to identify a PET you do not need to concern yourself with amounts, you just need to consider the recipient of the transfer.

Question 11

PETs are potentially exempt. The key to whether they become exempt is linked to the life of the donor.

Answer 11

If the donor survives for seven years after making the transfer, the transfer becomes exempt from IHT.

If the donor dies within seven years, the transfer becomes chargeable to IHT (a ‘Chargeable Transfer’ (CT)

Question 12

Do PETs need to be reported to HMRC?

Answer 12

No IHT is charged at the date of the transfer regardless of the size of the PET. It therefore does not have to be reported to HMRC at the time of making the transfer

Question 13

PET info

Answer 13

If the donor dies within seven years of the date of making the transfer, and the transfer becomes chargeable, it is the donee (i.e. the recipient of the gift) who is liable to pay any IHT due and has to report it to HMRC

NOTE:
Even if the donor dies within 7 years of making the gift, the overall valuation of the estate may have benefitted, as the maximum value of the gift in any future IHT calculation will be frozen at the value of the time of gift. Ie if it goes up in value since the gift is given this doesnt matter!

Question 14

CLTs are any type of transfer that are not on the exemption list or not classed as potentially exempt (see above for both)

Answer 14

By far the most common examples of these are transfers to trusts which are not bare or disabled trusts (the ones that are classed as PETs

Typically, these would be transfers to discretionary trusts (‘family trusts’ as the CII sometimes call them) or Interest in Possession trusts.

Question 15

The consequences of making a transfer that is classified as a CLT are:

Answer 15

the transfer (or a cumulation of all CLTs made in the previous seven years) does not exceed the prevailing Nil Rate Band (NRB), the tax charge will be at 0%

If the transfer (or a cumulation of all CLTs made in the previous seven years) does exceed the prevailing Nil Rate Band (NRB), the tax charge will be at 20% if paid by the trustees (the donee)

…

If there is an immediate IHT liability, this can be paid by either the donor or donee

Even if IHT is due on the payment of a CLT, there will be no further liability on that transfer if the donor survives for seven years after making the gift

If the donor does not survive seven years after making the gift, the transfer will become charged to IHT at the (higher) death rates

Question 16

NOTE:

Like PETs, the transfer would have been made during the donor’s lifetime and, therefore, they are often able to reduce the value of the gift for IHT purposes by the annual exemption (either 1 tax year’s worth, or by the maximum 2 tax years’ worth).

Question 17

Not relating to any exemptions or reliefs or types of transfer, What is always excluded from an estate for IHT.

Clue: Think domicile

Answer 17

Property outside uk where individual is non domicile in UK

Unit trusts or OEICs where the deceased in non domicile in UK

Reversionary Interests in trusts ( ie, a right to capital in a trust that was reliant on another beneficiaries rights ending first)

REMEMBER: If you are UK domicile, for IHT purposes all assets in the world are taxable. If you are non domicile however, you have a limit of transfers between yoru spouse as seen above (which would otherwise be unlimited if you were UK domicile) ie there is benefits and drawbacks to be being either uk or non uk domicile for IHT purposes

Question 18

What are Ineffective transfers?

Answer 18

Ineffective transfers are those that do not remove the property from the donor’s estate for IHT purposes. They are commonly known as ‘gifts with reservation’. Could result in a double-tax charge.

The most common example is where parents gift the deeds of their house to their children in an attempt to reduce the overall value of their estate, but remain living there and pay no (or ‘token’) rent:

Question 19

Valuing IHT transfers:

Answer 19

IHT transfers are valued by their ‘loss to the estate’.

In the majority of cases this is straightforward; if an individual gifts £100,000, their estate has lost £100,000.

It can get more complicated when, as an example, collections are split, or shareholdings are transferred. (LOOK AT EXAMPLE ON 4.2.6)

Question 20

There are currently four ‘official’ tax rates that could apply to IHT transfers:

What are they?

Question 21

Just as everyone is entitled to a personal allowance for income tax (chapter 1), a primary threshold per employment for NICs (chapter 2) and an annual exempt amount for CGT (chapter 3), everyone is entitled to an IHT Nil Rate Band (NRB).

Answer 21

Transfers up to the NRB are charged at 0% - hence the term the ‘Nil Rate Band’!

Question 22

Estates valued at more than £2,000,000 will see their RNRB gradually withdrawn or tapered away at a rate of £1 for every £2 excess over £2million. This tapering approach is commonly used in other tax calculations.

Answer 22

NOTE: When determining whether the £2 million threshold is breached, reliefs and exemptions are ignored. For example, business relief and agricultural relief are ignored when working out the estate value for the RNRB, even though they are taken into account to calculate the liability to IHT.

The £2 million is based on the value of the assets owned at the time of death, so it does not include any lifetime gifts made by the deceased, even if they become ‘failed PETS’, so and are included in the IHT calculation.

If we apply the £1 for every £2 excess rule, estates of £2.35 million or greater will not benefit from an RNRB.

If the deceased has brought forward an unused RNRB from a spouse or civil partner, then this can also be factored in. This means that some individuals may not see the RNRB fully disappear until the estate is worth in excess of £2.7 million.

Question 23

If part of a NRB is used on first death of a spouse how is this transferred to a spouse when it comes to their death?

Answer 23

The percentage of the NRB that can be transferred is based on the prevailing NRB at the time of first death.

The percentage (at the first death) of the unused NRB is used. LOOK AT EXAMPLE 4.6 & 4.7

NOTE: personal representatives at the second death had to ‘claim’ the transferred NRB percentages. That is because the process is not automatic. The claim should be made within 2 years of the end of the month in which the death occurs; or 3 months of beginning to act as personal representatives (if that is later)

Question 24

If you died before the RNRB was introduced (in 2017), you can still transfer the unused amount to a spouse if they died after it was introduced?. True or false

Answer 24

True

Question 25

What is taper relief

Answer 25

It is relief due on the tax due on a gift which becomes available if the donor lives for atleast 3 years following a gift. NOTE: It is NOT relief on the value of a gift. It is on the tax. DO NOT CONFUSE THIS. remember, 'No tax, no taper' SEE EXAMPLE, 4.1

Question 26

Remember. The cumulative value of CLTs must be in excess of the NRB within the last 7 years for an immediate lifetime IHT charge to be payable

Question 27

For the following scenarios, who's responsibility is it to pay the IHT bill? Any immediate lifetime tax due on a CLT Any further tax due on a CLT due to donor dying within 7 years Any tax due on PETs that have become chargeable due to donor dying within 7 years Any tax due on death, other than any mentioned above (ie, not including any gifts)

Answer 27

Any immediate lifetime tax due on a CLT = Donor or trustee of receiving trust (IF DONOR PAYS GROSSING UP PRINCIPLE MUST BE FOLLOWED) Any further tax due on a CLT due to donor dying within 7 years = trustee of receiving trust Any tax due on PETs that have become chargeable due to donor dying within 7 years = The recipient of the PET Any tax due on death, other than any mentioned above (ie, not including any gifts) = Deceased personal representatives OBVS, this means multiple different people could be responsible for paying IHT bills under one estate depending on the scenario

Question 28

An IHT rate of 36% can apply to estate. true or false?

Answer 28

True, but only where at least 10% of the 'net estate' is left to charity*. The 'net estate' (or the ‘baseline amount’ as it is sometimes referred to) is the gross estate less: Exempt transfers (but excluding the planned charity gift); The NRB (not the RNRB) and Reliefs This is one of the 4 official rates of IHT chargeable (0%, 20%, 36% & 40%) Remember the reliefs just reduce the official rates and IHT is charged at 0%, its just that it is 0& so nothing happens (hence why it is called the Nil rate band) SEE EXAMPLE 4.11

Question 29

What is the baseline amount in relation to IHT?

Answer 29

The net estate ie the gross estate - Exempt transfers (but excluding the planned charity gift); The NRB (not the RNRB) and Reliefs

Question 30

What are 'components’ of an estate?

Answer 30

A person’s estate for IHT is made up of all the property to which they are ‘beneficially entitled’. As a result, there could be a number of chargeable elements to their estate. HMRC describe these elements as ‘components’ of the estate. An example of a component would be the deceased’s share in a jointly-owned property. In such circumstances there are separate calculations for each component. The reduced rate applies separately to each component that makes up an estate, so it is possible that one component could be taxed at 36%, whilst others pay tax at the full rate.

Question 31

When is IHT on lifetime transfers due? When is IHT on death due?

Answer 31

When is tax on lifetime transfers due? 6 months after end of month of transfer or 30 April following year if lifetime transfer is made between 5th April - 1st October When is IHT on death due? 6 months after end of month of death SEE EXAMPLE 4.12

Question 32

Remember, when calculating cumulative lifetime transfer values to see if their is an immediate tax charge of 20%, you ONLY want to take into account the CLTs within the last 7 years. IGNORE any PETs !!!

Question 33

DO ACTIVITY 4.3. It is very good practise!!!!

Question 34

There are 6 reliefs available for IHT. What are they?

Answer 34

-Taper Relief (remember, ‘no tax no taper’) -Relief for drops in value - Applies to GIFTS. If recipient still owns the property at the point of IHT assessment, the value for the tax calculation is the market value at the date of the donor’s death. If the recipient has sold the property at arm’s length before the date of the donor’s death, the value for the tax calculation will be the market value at the date of sale (SEE 4.13) (REMEMBER PROPERTY DOESNT NECESSARILY MEAN HOUSES!!!) - Quick Succession Relief (QSR) - QSR is designed to address situations where the assets that make up estates could potentially be taxed twice. HMRC allow a reduction to the amount of tax to pay if there is a ‘quick succession' (5 years) LOOK AT 4.14 Business Relief - Business property (shares, assets ect) must have been owned for at least 2 years LOOK AT 4.4.4: !!!!! ( VERY USEFUL TO SEE ) Agricultural Relief - similar to that of Business Relief, EXCEPT FOR agricultural property (Agricultural land, growing crops and farm buildings) . DOES NOT INCLUDE Animals or equipment (business relief may apply here instead) Woodlands Relief - for those growing timber in the UK or the EEA. It applies to: The timber, not the land (which may qualify for Agricultural Relief) Only transfers on death. It operates by deferring the IHT until the disposal of the timber

Question 35

A key criterion necessary for satisfying the normal expenditure rule for exempt lifetime transfers is that the payments may only be made to qualifying life policies may only be made out of income may only be made if the annual exemption has not been used may only be made up to a value of £250 per tax year

Answer 35

may only be made out of income The three criteria for gifts out of normal expenditure are that they are regular in nature (‘habitual’) are made out of income (not capital) and do not impact adversely on the transferor’s standard of living

Question 36

Joseph died in March 2009 when the nil-rate band was £312,000. He had made a gift of £45,000 to his daughter 3 years earlier and left the remainder of the estate to his wife, Hilary. He made no other gifts or transfers. How much would Hilary’s nil-rate band be if she were to die in the current tax year? (Ignore the RNRB) £603,135 £604,987 £609,375 £611,000

Answer 36

£609,375 The gift of £45,000 was a PET of £39,000. This is £45,000 less 2 x annual exemptions, which we know weren’t used, as the question tells us Joseph ‘made no other gifts or transfers’. £39,000 ÷ £312,000 = 12.5% of the NRB utilised on first death. So, 87.5% was not used. Hilary therefore has access to 100% of her own NRB + 87.5% transferred from Joseph; £325,000 x 187.5% = £609,375

Question 37

Joanna, having made no previous transfers, gifts £500,000 in cash to a discretionary trust for her grandchildren. What rate(s) of Inheritance Tax are applicable at the time of the gift? 0% only 20% only 0% and 20% 0% and 40%

Answer 37

0% and 20% A transfer to a discretionary trust would be a Chargeable Lifetime Transfer. These types of transfer are charged at 0% up to the NRB and 20% above the NRB. The calculation needs to take into account CLTs made in the previous 7 years, but we were told in the question that Joanna had made no previous transfers. An ‘effective rate’ of 25% could have applied had Joanna opted to pay the lifetime IHT herself, but that was not included in any of the options. Incidentally, the CLT value would be £494,000 as Joanna would have 2 x annual exemptions available to her.

Question 38

In October 2018 (when the NRB was £325,000) Matthew gifted £400,000 to his daughter, Esme. Matthew died in August 2024 leaving an estate, without property valued at £600,000. He always made gifts to utilise his annual exemption and at the time of his death was divorced. Calculate the IHT due on the gift, if any, upon Matthew’s death stating who is responsible for its payment. £12,000, payable by Esme £30,000, payable by Esme £12,000, payable by either Esme or the legal personal representatives £30,000, payable by either Esme or the legal personal representatives

Answer 38

£12,000, payable by Esme The gift was a PET, so no IHT would have been due at the time of the gift to Esme. However, as Matthew did not live for 7 years after making the gift, it became a chargeable transfer. It would be measured against the NRB before the residual estate. So, the first £325,000 would be charged at 0%. The residual £75,000 is liable to the death rate of 40%, creating a liability of £30,000. Because Matthew lived for between 5 and 6 years after making the gift, the amount owed is subject to taper relief, so only 40% of £30,000 is payable. £30,000 x 40% = £12,000 liability. The responsibility for paying the liability is with the recipient of the gift, in this case Esme. Incidentally, this is an effective rate of tax of 16% (£12k liability on a £75k excess)

Question 39

Luis and Maria are married and are both resident in the UK. Luis is domiciled in Portugal and Maria is domiciled in the UK. On Maria's death, her £900,000 estate, which contained no property is inherited by Luis. How much Inheritance Tax, if any, would be due if her death occurs in the current tax year? Nil £100,000 £208,000 £230,000

Answer 39

£100,000 As the inheritance is passing from a UK domiciled individual to a non-UK domiciled individual, the full ‘inter-spouse exemption’ does not apply. Instead the exempt amount is the equivalent of the NRB, currently £325,000. That is in addition to the NRB itself, so the calculation is: (£900,000 - £650,000) x 40% = £100,000

Question 40

With regard to inheritance tax, Gemma, having fully used her annual gift exemption in the previous tax year, makes the following gifts in the current tax year i) £4,000 to her nephew aged 22 ii) £4,000 to her niece on her marriage iii) £1,000 split equally between her four godchildren Ignoring exemptions through the normal expenditure rules, how much of the money gifted will be deemed potentially exempt? £2,000 £4,000 £8,000 £9,000

Answer 40

£4000 READ QUESTION CAREFULLY. The £1,000 split between 4 godchildren will be £250 each and exempt under small gift rules. The £4,000 gift to the nephew can use Gemma’s £3,000 annual exemption to reduce the PET value to £1,000. The gift to niece on marriage can be reduced by £1,000 marriage gift meaning PET value £3,000. Total £4,000 of PETs.

Question 41

When Geoffrey died, his total estate on death was valued at £1,060,000. However, no IHT was paid in respect of his estate because he had previously been the sole recipient of his wife’s estate on her death he had a joint life second death whole of life policy in place the estate all qualified for maximum business relief the estate all qualified for maximum quick succession relief

Answer 41

Maximum business relief gives 100% relief, wiping out any IHT liability. Even if he had inherited his wife’s nil rate band, the maximum NRB he could use would be £650,000 (and, even with any transferable RNRB, the maximum would still be £1,000,000). Whole of life policies help meet an IHT liability, but don’t remove the liability itself. Although maximum QSR can reduce an IHT liability on death, it will not remove it altogether the estate all qualified for maximum business relief

Question 42

Freda, who was divorced, died in the current tax year. Her estate of £600,000 included a home valued at £180,000. In her will, she leaves half of the property to her step-son and half to her nephew. As a result, her total nil rate band set against her estate was: £325,000 £415,000 £500,000 £505,000

Answer 42

£415,000 The RNRB can only be applied when property is left to direct descendants. That includes step-children, and so applies in this case, but not nephews. As a result, half of the value of the property is eligible for RNRB, amounting to £180,000 ÷ 2 = £90,000. The maximum RNRB in 2024/25 is the lower of £175,000, or the eligible property value; in this case £90,000. That is added to Freda’s ‘normal’ NRB of £325,000, giving a total amount of £415,000.