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UK Inheritance Tax (IHT) Guide: Comprehensive Principles, Exemptions, and Planning

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UK Inheritance Tax (IHT) Guide: Comprehensive Principles, Exemptions, and Planning

 

Inheritance Tax (IHT) is a tax on the transfer of wealth upon death or during one’s lifetime in the UK. Understanding the basic principles of IHT, exemptions, and tax planning strategies can help minimize liabilities and ensure efficient estate planning.

1. Basic Principles of Computing Transfers of Value

Chargeable Persons

IHT applies to UK-domiciled individuals on worldwide assets and to non-UK domiciled individuals on UK-based assets.

Diminution in Value Principle

IHT is calculated based on the decrease in the donor’s estate value when a gift is made, rather than the recipient's gain.

Example:

  • David gifts £400,000 worth of property to his daughter.

  • If the property's market value decreases to £350,000, the IHT liability is based on the original value of £400,000.

The 7-Year Accumulation Principle

Lifetime gifts are added back into the estate if the donor dies within seven years, potentially increasing the IHT liability.

Example:

  • John gifts £300,000 to his son.

  • If he dies within 7 years, this is included in his estate for IHT purposes.

2. IHT on Lifetime Transfers and Death

Tax Implications of Lifetime Transfers

  • Potentially Exempt Transfers (PETs) – No IHT if the donor survives 7 years.

  • Chargeable Lifetime Transfers (CLTs) – Transfers into certain trusts may trigger an immediate 20% IHT charge.

Transfer of Unused NRB Between Spouses

  • If a spouse does not use their Nil-Rate Band (NRB) (£325,000), it can be transferred to the surviving spouse.

Residence Nil-Rate Band (RNRB)

  • An additional £175,000 relief applies when a main residence is passed to direct descendants.

Example:

  • David leaves his £1 million estate to his children.

  • £325,000 (NRB) + £175,000 (RNRB) = £500,000 exempt.

  • The remaining £500,000 is taxed at 40% (£200,000 IHT liability).

3. Exemptions & Reliefs to Minimize IHT

Exemptions

  • Gifts to spouses/civil partners (100% tax-free).

  • Gifts to charities (100% IHT-free & reduce IHT rate to 36% if 10% of the estate is left to charity).

  • Small gift exemption (£250 per recipient per year).

  • Annual exemption (£3,000 per tax year).

Business Property & Agricultural Property Relief (BPR/APR)

  • 50% or 100% IHT relief on qualifying business and agricultural assets.

Taper Relief (Reducing IHT on Gifts)

  • Applies to PETs if the donor dies within 7 years.

  • Reduces IHT liability on gifts made 3-7 years before death.

Years Before Death IHT Payable
0-3 years 100%
3-4 years 80%
4-5 years 60%
5-6 years 40%
6-7 years 20%
7+ years 0%

Example:

  • Susan gifts £500,000 to her son and dies 5 years later.

  • Instead of 40% IHT, 60% of the tax is reduced.

4. IHT Liabilities on Death & Reliefs

When to Pay 36% IHT

  • If at least 10% of the net estate is donated to charity, the IHT rate reduces from 40% to 36%.

Example:

  • Alice's estate is £1 million.

  • If she donates £100,000 to charity, the rest of the estate is taxed at 36% IHT instead of 40%.

IHT on the Death Estate

  • Any assets above the NRB (£325,000) are taxed at 40%.

  • RNRB applies for main residences left to direct descendants.

Quick Succession Relief

  • Reduces IHT if a beneficiary dies shortly after inheriting.

Double Tax Relief for IHT

  • If IHT is paid in two countries, a double tax treaty may apply to reduce taxation.

International Property Aspects

  • UK residents pay IHT on worldwide assets.

  • Non-UK residents pay IHT only on UK assets.

  • Excluded property: Overseas property held in foreign trusts may be outside the scope of IHT.

Example:

  • James, a UK resident, owns a villa in Spain worth £500,000.

  • His worldwide estate exceeds £325,000, making the villa subject to UK IHT.

  • Spain also charges inheritance tax, but double tax relief applies.

Deed of Variation

  • Allows beneficiaries to redistribute assets within two years of death, potentially reducing IHT liability.

Example:

  • Mike inherits £600,000 but redistributes £200,000 to his children under a Deed of Variation, lowering his IHT burden.

5. IHT & Trusts

Types of Trusts & IHT Implications

Trust Type IHT Implication
Bare Trust No immediate IHT charge, taxed as PET.
Discretionary Trust 20% IHT on assets above NRB + 6% periodic charge every 10 years.
Interest in Possession Trust No IHT on life tenant’s estate, taxed at 40% on death.

6. IHT Administration & Payment

Payment of IHT by Instalments

  • IHT on assets like property can be paid over 10 years.

IHT Payment Due Dates

  • Within 6 months of death.

  • Late payment incurs interest & penalties.

7. IHT Planning & How Acumen Can Help

IHT planning is essential to reduce liabilities and ensure smooth wealth transfer. Acumen Accountants and Tax Advisers provide expert guidance on trusts, exemptions, estate planning, and tax efficiency strategies.

Our Services Include:

✅ Estate & trust planning
✅ Lifetime gift tax optimization
✅ Use of exemptions & reliefs
✅ Business succession & BPR/APR claims
✅ International IHT planning & double taxation relief

Final Thoughts

For expert IHT planning, contact Acumen Accountants and Tax Advisers today.

📞 07534473220
🌐 www.acumenagc.com
✉ info@acumenagc.com
🏢 37th Floor, 1 Canada Square, London E14 5DY
📅 Book Online Meeting Here

 

Disclaimer

This guide is for informational purposes only and does not constitute professional legal or tax advice. Tax laws and regulations are subject to change, and individual circumstances may vary. It is recommended to consult a qualified accountant or tax professional for tailored advice on inheritance tax planning.