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1 Minute Guide to ... Inheritance Tax (IHT)
(July 2004)
Introduction
Inheritance Tax (IHT) is becoming an important consideration for an increasing number of taxpayers. As a result of spiralling property values, the family home is often a major factor in many people falling into the IHT 'net' for the first time. This '1 minute guide' highlights some basic IHT principles as an initial reference point for taxpayers, and is a possible 'memory jogger' for professionals.
10 Key Points
- Scope of IHT
An individual who is domiciled in the UK is liable to IHT on chargeable property on a worldwide basis. A non-UK domiciled individual is also liable to IHT, but only on chargeable property in the UK.
- Domicile for IHT purposes
In addition to the legal concept of domicile, for IHT purposes an individual can be deemed domiciled in the UK if he or she was UK domiciled at any time in the 3 years immediately preceding the time at which the question of domicile is to be decided, or alternatively UK resident for at least 17 out of the last 20 years ending with the tax year in which a chargeable event takes place.
- What is a 'Chargeable transfer'?
IHT is levied on chargeable transfers made during an individual's lifetime, and on the value of his or her death estate. A 'chargeable transfer' is a transfer of value made by an individual, other than an exempt transfer.
- Inter-spouse transfers
A number of IHT exemptions exist. Perhaps the most well known and commonly used exemption is for gifts between spouses, although it should be noted that if, immediately before the gift, the transferor but not the transferee spouse is domiciled in the UK the exemption is limited to a gross cumulative total of £55,000. The spouse exemption applies to both lifetime transfers and transfers on death.
- Other exempt transfers
There are various IHT exemptions for lifetime transfers. The annual exemption allows individuals to make gifts of up to £3,000 per tax year in total. Any unused exemption may be carried forward, and added to the annual exemption for the following year only. Other lifetime exemptions include a 'small gifts' exemption, an exemption for certain gifts in consideration of marriage and an exemption for normal expenditure out of income if certain conditions are satisfied.
- Potentially Exempt Transfers (PETs)
A PET is a lifetime transfer of value which would otherwise be a chargeable transfer, and is a gift to an individual or certain types of trust, i.e. an accumulation and maintenance trust or a trust for the disabled. A PET made 7 years or more before the transferor's death is exempt for IHT purposes. Otherwise, the PET is a chargeable transfer.
- Chargeable Lifetime Transfers
A chargeable lifetime transfer is a transfer of value made by an individual, and which is not (potentially or otherwise) an exempt transfer, e.g. transfers into a discretionary trust. If the donor agrees to bear the IHT liability, the tax further reduces the value of the estate. The transfer is therefore 'grossed up' on a tax-inclusive basis to arrive at the chargeable transfer.
- How is IHT calculated on chargeable lifetime transfers?
Chargeable transfers are taken into account on a cumulative basis. The transfers are aggregated over a 7-year period, after which they fall out of the cumulative total. The amount of IHT on the latest transfer is determined by reference to this total. Tax is charged at half the IHT rate on death (i.e. at a 'lifetime rate' of 20% for 2004/05), to the extent that the 'nil rate band' (i.e. £263,000 for 2004/05) is exceeded, after deducting annual exemptions etc.
- How is IHT calculated on the death estate?
If an individual dies within 7 years of making a chargeable lifetime transfer, IHT on recalculated at the full 'death rate' on the transfer (i.e. 40% for 2004/05), subject to 'taper relief' if the death is more than 3 years after the gift. In addition, the individual is treated as making a notional transfer of the whole estate immediately prior to death, and IHT is charged accordingly.
- Where there's a Will!
A Will helps to ensure that a person's death estate passes in accordance with their wishes, rather than under the law governing intestacy. A deceased individual's estate (under a Will or the laws of intestacy) may be varied (or alternatively disclaimed) following death. For IHT purposes, a variation is treated as if made by the deceased. A written deed of variation must be made within 2 years of the death.
Disclaimer
The content of these guides is based on tax legislation in operation at the time of publication, which may subsequently have changed. Whilst every care has been taken in its production, no responsibility can be accepted for any action undertaken or refrained from as a consequence of this material. This information is for general guidance only. Specific professional advice should always be obtained based on personal circumstances. TaxationWeb Limited accepts no responsibility whatsoever for any action undertaken or refrained from as a result of the information contained herein.