Inheritance Tax Flashcards
(27 cards)
What are the three main times when IHT may be charged?
1) Death - Charged on value of estate (assets less their liabilities)
2) Lifetime gifts made to individuals within 7 years prior to death
- Potentially exempt transfers (PETs) - at the time the gift/transfer is made, no IHT is chargeable and if the transferor survives for 7 years, the transfer becomes exempt
- If they die within 7 years of the gift, it becomes chargeable to IHT
3) Lifetime gifts to a company or into a trust
- Lifetime chargeable transfers - These are immediately chargeable to IHT at the time of transfer, unless the trust is for a disabled person
What is the basic four stage process to calculating IHT?
1) Identify the transfer of value
- A transfer of value is a disposition which reduces the value of the transferor’s estate (gift of an asset)
- On death, the value transferred is the value of the deceased’s (D) estate immediately before death
2) Find the value transferred
- For a lifetime transfer (LT), this is the amount of the reduction in the transferor’s estate
- On death, it is the value of the estate
3) Apply any relevant exemptions and reliefs
4) Calculate tax at the appropriate rate
- Nil rate band goes up to £325,000 – available for all transfers of value
- Residence nil rate band goes up to £175,000 – available only on a transfer on death where there is a ‘qualifying residential interest’
How do we check how much of the NRB is available for a particular transfer?
Look back over the 7 years preceding any transfer as any chargeable transfers made by the transferor during that period must be considered to determine how much of the nil rate band remains available
This is called ‘cumulation.’
Example - A gifts B £10k in 2023 and dies in 2024. They will therefore only have £315,000 of their NRB to use on death.
What types of property fall within the definition of ‘estate’ on death?
All property to which D was beneficially entitled immediately before death, with the exception of excluded property. Includes:
- Property passing under will/intestacy
- Property they were beneficially entitled to, but that didn’t pass under will (beneficial joint share in a property passing by survivorship)
- Certain trust property
- Where property given away, but ‘possession and enjoyment’ not transferred, so D still treated as beneficially entitled
What trust property might fall within the definition of ‘estate’ on death?
1) A person who is entitled to trust income is treated for IHT purposes as beneficially entitled to the capital which produces the income, so when they die, the trust fund is taxed as part of D’s estate
- Known as qualifying interest in possession, but will only arise in limited circumstances
2) Main example is where the interest is an ‘immediate post-death interest’ which is an interest in possession arising on the death of the settlor under their will or intestacy
- A leaves money held on trust to pay income to B for life with remainder to C; B has an interest in possession and will be treated as beneficially entitled to the whole trust fund for IHT purposes on death
How do we calculate the ‘value transferred’ on death?
Assets in the estate are valued for IHT purposes at ‘the price which the property might reasonably be expected if sold in the open market’ immediately before death
Where death increases or decreases value of the asset, the change in value must be considered (life insurance policy for D’s benefit increasing to £50k on death; value for IHT purposes is £50k)
Debts/liabilities owed by D at time of death are deductible for IHT, as are reasonable funeral expenses
When a house is transferred to a sibling or friend, not spouse/child (as spouse exemption and RNRB would apply), a 15% discount is applied, so the IHT value (before tax charged) is 15% less than it would have been
Explain the spouse and charity exemptions that can apply on death
1) Spouse exemption - Any property included in the estate for IHT purposes is exempt if it passes to D’s spouse or civil partner under D’s will/intestacy or, in the case of joint property, by survivorship
- Doesn’t apply to cohabitees at all
2) Charity exemption - Any property forming part of the deceased’s estate for IHT purposes which passes on death to charity is exempt
How does business property relief work?
1) Reduces value transferred of relevant business property by a certain percentage
- Only applies where business is ‘trading’ in nature
- To attract relief, assets must have been owned for at least two years at time of transfer
2) Reduction of 100% for transfers of value of:
- A business or interest in a business
- Company shares that aren’t listed on a recognised stock exchange (unquoted/private limited shares)
3) Reduction of 50% for transfers of value of:
- Company shares listed on recognised stock exchange if transferor had voting control of the company immediately prior to transfer (over 50% of votes on all resolutions)
- Land, buildings, machinery or plant owned by transferor personally, but used for business purposes by a partnership of which the transferor is a member, or by a company of which the transferor has voting control (over 50% of votes on all resolutions)
How does agricultural property relief work?
1) Reduces agricultural value of agricultural property by a certain percentage
- To attract relief, must have been occupied for purposes of agriculture for 2 years prior to the transfer
- The ‘agricultural value’ is the value of the property if it were subject to a perpetual covenant prohibiting its use other than for agriculture
2) Reduction of 100% is allowed where transferor had right to vacant possession immediately before transfer
3) Reduction of 50% in other cases
Explain the Nil Rate Band in more detail and the rate of IHT on death
1) If D made no chargeable transfers in the 7 years before death, the rate of tax is 0% on the first £325,000 of the estate at death
2) If the estate exceeds £325,000, IHT is charged on the excess at 40%
- Rate of 36% applies when 10% of estate left to charity
3) If D survives a spouse, the unused NRB from the first dead spouse is used to increase D’s NRB (ie if X used none, Y could pay no IHT on the first £650,000 of the estate)
4) Any chargeable transfers made in 7 years before death use up D’s NRB first, reducing the amount available for the estate
- Value transferred by lifetime transfers must be aggregated, meaning lifetime exemptions and reliefs are considered
5) Example - A gifts B £175,000 in 2021; A dies in 2024, leaving their £200,000 estate to C
- NRB reduced by £175,000, so first £150k of estate is nil and £50k is taxed at 40%
Explain the Residence Nil Rate Band in more detail
1) RNRB is £175,000 + applies in addition to NRB
- Only applies up to the value of D’s residence
- RNRB taxed first at 0%, then NRB at 0% and then remaining death estate at 40%
- RNRB is reduced by £1 for every £2 over £2 mil when the estate has this value and over (£175,000 - ((value of estate - £2 mil)/2) = adjusted RNRB
2) Unused RNRB can be claimed by a surviving spouse
3) To apply, D must die owning a ‘qualifying residential interest’ which is ‘closely inherited.’
- QRI is an interest in a dwelling house which has, at any time, been D’s residence and forms part of their estate
4) To be closely inherited, it must pass to:
(i) a child, grandchild or other lineal descendant of the deceased outright (step, adopted and foster children) or on certain types of trust
(ii) the current spouse or civil partner of the deceased’s lineal descendants; or
(iii) the widow, widower or surviving civil partner of a lineal descendant who predeceased the deceased, unless such persons have remarried or formed a new civil partnership before the deceased’s death.
What is the transfer of value for a potentially exempt transfer (PET)?
Any lifetime disposition which reduces the value of the estate
Spending £20 to get £20 of chattels wouldn’t count
How do we calculate the ‘value transferred’ for PETs?
1) Generally, it is calculated as the loss in value to the estate; loss is usually market value
2) However, if A has two vases worth £80,000 as a pair, but individually worth £25,000, giving away one will cause a loss of £55,000 (value as pair – value of remaining vase = loss to estate)
3) The related property rules also create differences
- B has two vases worth £50,000 as a pair, but individually worth £15,000
- Giving away one to spouse C would normally mean each owns one vase of £15,000
- But the related property rules mean that because they are married, each vase is valued at the appropriate portion of the set (half of £50,000 here)
- So, if B gave away their one vase now or when it passes in the estate on death, the value transferred is £25,000
How do the exemptions that apply on death, also apply to PETs?
1) Spouse and charity exemptions apply, so gifts in these contexts are exempt, even if transferor dies within 7 years
2) Business and agricultural property reliefs also apply on lifetime transfers
- However, if the transferor dies within 7 years, BPR and agricultural property given at time of LT will be withdrawn unless **transferee still owns the BP/agricultural property at the date of T’s death **
3) Exemptions applied before reliefs, so business property transferred to spouse is exempt
What exemptions apply exclusively to lifetime transfers?
1) Annual exemption – first £3000 transferred each tax year is exempt; if unused, can be carried forward for one year, so could transfer £6000 exempt in Y2
2) Small gifts – lifetime gifts in one tax year of £250 or less to any one person are exempt – cannot be set against a gift exceeding £250
3) Normal expenditure out of income – lifetime transfers exempt if:
(a) it was made as part of the transferor’s normal expenditure; and
(b) it was made out of the transferor’s income; and
(c) after allowing for all such payments, the transferor was left with sufficient income to maintain their usual standard of living
- Payments from parent to child for living expenses would be an example
4) Gifts in consideration of marriage – lifetime gifts on marriage are exempt up to:
a) £5,000 by a parent of a party to the marriage;
(b) £2,500 by a remoter ancestor of a party to the marriage (eg a grandparent); and
(c) £1,000 in any other case
Give a more detailed overview of lifetime chargeable transfers
1) Main example is a LT into a trust (other than disabled trust) or company
2) Once relevant exemptions and reliefs applied (except small gifts exemption which doesn’t apply to LCTs), outstanding balance is immediately chargeable to IHT
- 0% on first £325,000 (NRB)
- 20% after this
3) Chargeable transfers made in the seven years before the current chargeable transfer reduce the NRB available to that current transfer. In other words, the value transferred by chargeable transfers made in the seven years before the current chargeable transfer must be ‘cumulated’ with that transfer
4) Example - X makes a LCT in 2016 of £100k, in 2019 of £280k and in 2024 of £50k
- 2016 transfer ignored as more than 7 years old
- NRB = £325,000 - £280,000 (within 7 years) = £45,000
- So, X has £45,000 at 0% and £5000 at 20% on 2024’s transfer
PETs made in the 7 years prior to death before chargeable on death. How would we calculate the IHT payable on a PET on death?
Firstly and secondly - identify the transfer of value and the amount of value
Thirdly - do any exemptions or reliefs apply?
Fourthly - calculate tax at appropriate rate, by calculating cumulative total of transfers at time of PET - this will reduce the NRB available for that PET and then for death
Cumulative total consists of:
- (a) any LCTs made in the seven years before the PET being assessed (even if the LCT was made more than seven years before the transferor’s death – therefore a taxpayer who makes an LCT may have to survive for 14 years before it ceases to have any impact); and
- (b) any other PETs made during the seven years before the PET being assessed which have become chargeable as a result of the transferor’s death
What is tapering relief and how does it apply to lifetime transfers on death?
Tapering relief is available where T survives more than three years after the transfer and works by reducing tax payable on the PET or recharged LCT
Tax is reduced to the following percentages:
(a) transfers within three to four years before death: 80% of death charge
(b) transfers within four to five years before death: 60% of death charge
(c) transfers within five to six years before death: 40% of death charge
(d) transfers within six to seven years before death: 20% of death charge
Give an example of the effect of death on PETs
All NRB used up – L makes a gift of £96,000 to Y in 2018 and dies in 2024
After annual exemptions, PET is £90,000 which will all be taxed at 40% = £36,000
L died within six to seven years of PET, so Y must only pay 20% of £36,000 = £7200
LCTs made in the 7 years prior to death are recharged at the death rate (40%) on death. How would we calculate the IHT payable on a LCT on death?
Steps 1-3 - identify transfer of value, amount of value and see if reliefs still apply (must hold business or agricultural property on death for it to work)
Step 4 - calculate tax at appropriate rate; cumulative total relevant to LCT will determine how much NRB is available
Cumulative total consists of:
- (a) any other LCTs made in the seven years before the LCT being assessed (even if such earlier LCTs were made more than seven years before the transferor’s death); and
- (b) any PETs made during the seven years before the LCT being assessed which have become chargeable as a result of the transferor’s death.
- Each transfer that becomes chargeable or rechargeable has its own cumulation period, which means that a taxpayer who makes an LCT may have to survive for 14 years before it ceases to have an impact.
Give an example of the effect of death on LCTs
Tapering relief also applies, but ensure you deduct tax that was already paid (when it was taxed at 20%)
Example - Transfer of 50,000 at 20% = £10,000; recalculated to 40% (£20,000) on T’s death
But if T died within 3-4 years, only 80% of £20,000 is payable (£16,000 - £10,000 already paid = £6000 to pay)
Give an example of LCT, PET and death together
- £300k gift in trust in 2011
- £100k PET in 2017
- Death in 2024
2017 PET is now chargeable and has its own cumulation period, so the £300k trust gift will count towards NRB, leaving £25k NRB for 2017 gift
As the 2011 trust gift is more than 7 years old though, it won’t be reassessed at 40%; it just counts for cumulation
After using all NRB, there will be £75k of the 2017 PET and whatever the estate comprises that is taxable
If the 2011 gift was a PET, it wouldn’t be considered for cumulation as only chargeable PETs are used for cumulation
When is IHT payable?
1) IHT is due for payment 6 months after the end of the month of death – interest applies for late payment (this is the case for PETs and LCTs reassessed on death too)
2) For land, business or interest in a business, shares giving control of a company to D and certain unquoted shares, IHT can be paid in 10 equal yearly instalments (instalment property)
- No interest to pay if instalment paid on each due date
What is the ‘estate rate’ and why it is useful?
1) It is the average rate of tax applicable to each item of property in the estate; principle is that tax is divided between the various assets in the estate proportionately, according to their value
2) Can be used to calculate tax on non-instalment type property, as IHT on this must be paid before any grant of representation can be obtained
3) Estate rate = (total tax bill divided by total chargeable estate) x 100
4) Example -House valued at £210,000, total tax bill is £30k and estate is £400k
(30k/400k) x 100 = 7.5%
£210,000 x 7.5% = £15,750 (what the beneficiary pays in IHT on house)
