MW TAX

UNDERSTANDING UK INHERITANCE TAX

As UK accountants and tax advisers, we want to help you make sense of it all and ensure that you are equipped with the right information to avoid surprises when the time comes. Here’s a simple guide to UK Inheritance Tax—what it is, when it applies, and how it affects you.

What is Inheritance Tax?
Inheritance Tax is a tax on the estate (property, money, and possessions) of someone who has passed away. It’s levied on the value of the estate, not on the individual’s income or assets during their lifetime. Essentially, it’s a tax that is paid on the transfer of assets on death.

In the UK, if the total value of a deceased person’s estate exceeds a certain threshold, IHT may need to be paid. The current threshold is £325,000, which means if the estate’s value is below this amount, there will generally be no IHT to pay. However, if the estate is above this threshold, Inheritance Tax could apply.

When Does Inheritance Tax Apply?
Inheritance Tax only applies when the value of the estate exceeds the £325,000 threshold. The threshold can be higher in certain cases. For example, if the deceased leaves their home to children or grandchildren, the "residence nil rate band" can increase the threshold up to £500,000. This means that if the estate’s value is below this higher threshold, no IHT will be due.

In addition, there are certain gifts that are exempt from Inheritance Tax, such as:

• Gifts between spouses or civil partners

• Gifts to registered charities

• Small gifts under £250 per person

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Inheritance Tax also has an important time element. If the deceased made gifts in the seven years before their death, these could still be subject to tax. The closer to death these gifts were made, the higher the potential tax rate.

How Does Inheritance Tax Work?

If your estate exceeds the tax-free threshold, the Inheritance Tax rate is usually 40% on the value above the threshold. For example, if the estate is worth £400,000, IHT would be charged on £75,000 (the amount above the £325,000 threshold). This means the tax due would be £30,000 (40% of £75,000).

However, the tax rate can be reduced to 36% if 10% or more of the estate is left to charity, making charitable donations a valuable strategy for those looking to reduce their inheritance tax liability.

How Can You Minimise Inheritance Tax?
There are various strategies that can help reduce the impact of Inheritance Tax, and this is where expert advice from accountants and tax advisers comes into play. Here are a few options to consider:

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1. Making Gifts During Your Lifetime: As mentioned earlier, gifts made during your lifetime may be exempt from inheritance tax, particularly if made early enough. Proper planning with professional advice can help ensure you make gifts in a way that is most tax-efficient.

2. Using Trusts: Setting up a trust can help you pass on assets to beneficiaries while potentially reducing IHT. Trusts can be complex, but an experienced accountant or tax adviser can guide you through the process and help set up the right trust for your needs.

3. Taking Advantage of Exemptions: There are several exemptions and reliefs that can help reduce or eliminate the tax burden, such as the annual gift exemption and exemptions for certain types of property, including business property or agricultural land. An expert adviser will know how to maximise these benefits.

4. Planning Your Will: Creating a will that clearly outlines your wishes can help to ensure your estate is distributed according to your preferences and in the most tax-efficient manner. 

5. Reviewing Your Estate Regularly: Estate values can change over time, and it’s important to regularly review your estate plan to keep it in line with the current laws and thresholds.

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Tax Compliance Obligations for Inheritance Tax

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One of the key aspects of dealing with Inheritance Tax is ensuring proper tax compliance. There are specific legal requirements that must be met when administering an estate, and failure to comply with these requirements can lead to penalties, fines, and even legal action. Here’s an overview of the key tax compliance obligations:

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1. Inheritance Tax Return (IHT400): If the estate exceeds the tax-free threshold, an Inheritance Tax return (IHT400) must be completed. This return provides detailed information about the estate’s value, assets, liabilities, and any gifts made in the seven years before death. It is essential that the form is filed accurately and on time to avoid penalties.

2. Payment of Inheritance Tax: Inheritance Tax is usually due within six months from the end of the month in which the death occurred. If the tax is not paid on time, interest will accrue. It’s important to ensure that the funds to cover the tax are available. In some cases, IHT can be paid in instalments, particularly when the estate consists of illiquid assets, such as property or business interests.

3. Record-Keeping: Accurate record-keeping is vital throughout the estate administration process. All documents related to the estate, including valuations, proof of gifts, and details of the IHT return, must be carefully kept for future reference. HMRC can request documentation at any time.