I’m an inheritance tax expert, and these are five key things everyone should be aware of amid the HMRC crackdown

Heather Pollard, Head of Underwriting at Tower Street Finance explains the recent rise in HMRC investigations of Inheritance Tax payment errors, and explains how Brits can best protect themselves from an unexpected bill.

When dealing with the short- and long-term effects of bereavement, any unexpected impacts to your financial well-being can cause further stress in an already difficult and upsetting time.

However, this has been a reality for a growing number of UK families due to a rise in HMRC investigations regarding underpaid death duties.

The government agency issued requests for £326 million in payment shortages in 2021/22 alone, which is an increase of over a quarter on the previous tax year (28%).

One of the biggest causes of a potential inheritance tax underpayment comes from gifts made within seven years of a loved one’s death, with increasing asset values (higher house values for examples) pushing Estate values above tax free thresholds.

To help people understand if they could be affected by these unpaid or underpaid death duty crackdowns, Heather Pollard, Head of Underwriting at inheritance experts Tower Street Finance – a company that helps people access their inheritance quicker – has pulled together some useful information and top tips.

1. Explaining Inheritance Tax allowances

Inheritance Tax, or IHT as it is also referred to as, is the tax that is charged on the value of an Estate that was owned by someone who has passed away.

The term Estate refers to all their property and valuables. This includes bank accounts, pensions, homes or other buildings / land, jewellery, vehicles, shares, jointly owned assets, and pay-outs from insurance policies.

Any debts, such as mortgages, funeral expenses, other taxes or expenses are taken from the total Estate value first, and then Inheritance Tax (IHT) is only paid on the remaining amount – and only if it exceeds the Inheritance Tax threshold.

At this time, the single person’s Inheritance Tax threshold is currently £325,000. So, tax is only ever paid if the value of the Estate is over this figure.

The current tax rate is set at 40%.

That means that if you inherit an Estate with a value of £326,000, you’d only pay 40% tax on the £1,000 that is over the tax threshold. So, you’d pay £400 in Inheritance Tax.

2. The rules are a bit different for married or registered civil partners

Married or registered civil partners don’t have to pay any Inheritance Tax on any asset (money or valuable) left by their spouse.

When the second partner passes away, the Estate then qualifies for something called a married couple’s ‘transferable allowance’. This is essentially the Inheritance Tax threshold times two (for two people) and it currently stands at £650,000 – but only if none of the threshold has been previously used.

The person who then inherits this Estate would only pay tax on anything over the value of £650,000. This extra transferable element is known in the business as the Transferable Nil Rate Band (or TNRB).

3. You do not pay tax on cash gifts, but there are strict rules.

While someone is still alive, they can gift as much money or items of value as they want, to anyone they want, in the form of something called ‘potentially exempt transfers’ (also known as PETs).

However, if that person passes away, those gifts (or PETs) can then be included in the total value of their Estate and therefore Inheritance Tax may end up having to be paid.

Under the current rules, if the gift is given before death, and the donor (the person who gave the gift) lives for more than seven years after this, then no Inheritance Tax needs to be paid.

However, if the donor dies sooner, then tax will be charged on the gifts at various levels – but only if the Inheritance Tax threshold is exceeded.

The various levels are:

• Within 3 years of giving the gift – 40% Inheritance Tax is paid on anything over the threshold
• Within 3 to 4 years – 32%
• Within 4 to 5 years – 24%
• Within 5 to 6 years – 16%
• Within 6 to 7 years – 8%
• After more than 7 years – 0%

Gifts use up the Inheritance Tax threshold before any other assets, such as property and other valuables, are calculated. They are also based on what they were worth at the time of donation, not what they were worth at the time of the donor’s death.

4. Several types of gifts are exempt from Inheritance Tax

It’s worth being aware that there are several types of gifts that are exempt from IHT. These are:

• Gifts to your spouse or civil partner
• Gifts to charities
• Multiple gifts up to £250 a year to any other person
• Payments to help an elderly relative or minor with living costs
• Gifts worth £3,000 or less in any tax year (excluding any £250 gifts, provided they are not to the same person)
• Gifts made seven years or more before the donor (gift giver) passed away

Also, when a couple gets married, some family members are also allowed to give the following wedding gifts, and these are exempt from potential Inheritance Tax at any point in time too:

• Parents can gift cash up to £5,000
• Grandparents can gift up to £2,500 each

5. Best practice to avoid unexpected Inheritance Tax Bills

While nobody wants to envision a time without their loved ones, a small amount of forward planning can make a real difference.

• To avoid any confusion later down the line, keep track of any gifts you have been given, who they were from, the value of the gift and when it was given. If HMRC query any gifts, it will be up to you to provide this detail and prove the gift was given over seven years ago in order be applicable for the 0% tax rate.
• Make use of the annual Inheritance Tax gifting exemptions and pay attention to how these differ depending on who the gift was given by.
• Look into different types of Trust that can help protect or manage an estate, giving greater control over what happens to assets and how they can be used once a loved one has passed away. Keep in mind however, that there are variations on Trusts, and they could potentially end up costing you more, so think carefully and seek appropriate advice before heading down this road.
• While Trusts can give you greater control, it is a misconception that assets in Trusts are completely exempt from Inheritance Tax, with most Trusts paying 20% when set up (if it’s worth more than the Nil-Rate Band).
• The most common Trust used in connection with Inheritance Tax planning is a Discretionary Trust, which follow the below tax rules:
  • Upon set up – Pay 20%
    • Start by working out the value of the asset that’s not covered by your personal allowance. You’ll pay a 20% tax charge on this amount when the Trust is set up.
  • Every 10 years – Pay 6%
    • Any assets in the Trust need to be re-valued each decade. After that, a 6% charge is levied on the value of the total assets, less the £325,000 IHT allowance.
  • Upon closing the trust – Pay 6%
    • Finally, IHT will need to be paid again when the Trust is closed, or if assets are removed. Tax is based on the most recent 10-year anniversary valuation, up to 6%, charged on a pro-rata basis.

For further information about Inheritance Tax click here.