Many people do not realise what is involved when dealing with the assets and debts of a person who has died. It can be a complex and onerous task, especially at a time when someone will have lost a loved one and may well be grieving. Though, the task of sorting out a loved one's estate is soon to become a little easier with the government promising to remove the need to have to complete tax forms in estates where Inheritance Tax isn't due - around 250,000 estates. But what does this mean for the 25,000 estates in the UK which will have to pay Inheritance Tax?
With £5.3 billion being paid in Inheritance Tax every year, let's explore the main things an Executor (or next of kin) will need to consider when it comes to Inheritance Tax.
1. Form Filling
The Executor appointed in the Will or the next of kin in the absence of a Will are responsible for finalising the tax position of the estate. They will still need to gather full and accurate details of their loved ones financial affairs, complete as many as 25 different HMRC forms and grapple with, what can often be complex tax legislation.
As well as this, they will need to apply to the Courts for a Grant of Probate (or Letters of Administration where there is no Will), which gives them the the legal authority to manage the estate, and to sell and transfer assets. They are also responsible for settling any debts and then finally paying the estate to the beneficiaries as set out in the will or according to the laws of intestacy.
The Executor (or next of kin) should not pay any beneficiary money until the tax bill has been settled. If they do and tax is outstanding, they are likely to be held personally liable by HMRC, which means they may have to put things right out of their own pocket.
2. Inheritance Tax deadlines
Inheritance Tax has to be paid within six months of the death although you have a year to submit the forms. If tax is paid late, interest is charged. As well as the Inheritance Tax account, an Income Tax return for the year of death, as well as for the administration period may need to be submitted and could result in another tax bill.
3. Rates of Tax
Inheritance Tax is paid at a rate of 40 per cent on the net value of a person’s estate after exemptions, deductions, reliefs and allowances are applied. If more than 10 per cent of an estate is left to charity a lower rate of Inheritance Tax is payable, 36 per cent. It is possible to claim a tax refund if a property or shares are sold for less than their stated value on the Inheritance Tax returns, but only within a limited timeframe.
4. Paying the Tax
Well here's the catch. The Executor (or next of kin) can't release the assets belonging to the person who has died; without first obtaining the Grant of Probate (or Letters of Administration) but they can't obtain the grant until they have paid the Inheritance Tax due. How can they pay the Inheritance Tax without being able to access the funds? If there are liquid funds, i.e. cash in the estate; this can sometimes be used to pay HMRC. Otherwise the beneficiaries have to pay or the Executors (or next of kin) may need to borrow the money or secure a loan.
If the main asset, such as the person’s home or business, is not being sold, then the Inheritance Tax can be paid in 10 yearly instalments though interest will be charged. If the asset is sold later then the balance must be paid in full.
6. Going back in time
Lifetime gifts are a popular way for people to reduce the values of their estates. The Executor (or next of kin) is required to declare all gifts made by the person who has died within the seven years prior to their death, since these may still be part of the estate and may use up any available Nil Rate Band. Even gifts made outside the seven-year window can be caught by the reservation of benefit and pre-owned assets rules so may not be exempt.
7. Maximising the Nil Rate Band
The Standard Nil Rate Band is the threshold above which Inheritance Tax (IHT) is paid. The Nil Rate Band is currently £325,000 and has been fixed at this amount for the last 10 years and continues to be fixed until April 2026. This means that the first £325,000 of your belongings, property and cash can be gifted free of Inheritance Tax. Anything over this amount is taxed at 40%.
If the threshold has not been fully used when the first person in a marriage or civil partnership dies, then that unused part can go to the surviving husband, wife or civil partner when they die. The basic tax-free threshold available when a wife, husband or civil partner dies can be as much as £650,000 if none of the £325,000 threshold was used when the first of the couple died.
The percentage of the threshold that was not used when the first partner died increases the basic threshold that’s available to their estate. This is not automatic and the Executor (or next of kin) will need to apply for this.
In addition, the Residence Nil Rate Band was introduced in 2007, which effectively means that married couples or those in a civil partnership can gift £1m before Inheritance Tax becomes payable where the estate involves a property being left to direct descendants.
The Residence Nil Rate Band can still be applied to the value of a person’s original home if they downsized or sold their home after 8 July 2015, provided direct descendants inherit some of the estate. But if the deceased’s home or share of their home is left in a discretionary trust, RNRB may not be available, although it is possible to have this read back into the will and treated as a disposition made by the deceased's will. For estates worth more than £2m, the Residence Nil Rate Band is tapered away and can be reduced to zero.
8. Reliefs for Businesses and Farms
It is possible to claim relief from Inheritance Tax for some businesses and farms through Business Relief (BR) and Agricultural Relief (AR). Buy-to-let activities are not covered by BR – even if the individual was a full-time landlord and the properties are held in a corporate structure. They are always deemed investment activities, as are furnished holiday lettings.
9. What's not included?
Because pensions are typically written in trust they do not form part of an individual’s estate, apart from any cash lump sums that have been drawn out, and they are not controlled by the will.
10. Is there a way around paying Inheritance Tax?
Inheritance Tax is said to be the only voluntary tax. Many people do not realise that a Will can be altered following the death of the testator; but if the beneficiaries are all adults (i.e. over the age of 18) and they all agree, then they are permitted to change a Will and even the rules of intestacy. This has to be in writing and is known as a Deed of Variation, an Instrument of Variation or a Family Arrangement. Often these types of deeds are used to improve the tax planning or to make provision for another beneficiary. For example:
A beneficiary may wish to redirect their entitlement to other members of the family who are less well provided for; or
To save tax, often Inheritance Tax especially if the deceased's Nil Rate Band and any exemptions and reliefs have not been fully utilised. Or to decrease the effective rate to 36% (from 40%) if more than 10% of the estate is being left to charity.
The deed has to be entered into within 2 years following the death of the testator and must be drafted by a qualified professional. Where a minor beneficiary's interest is to be varied, then court approval may be required, and irrespective of this a minor's share cannot be decreased, it must either stay the same or increase in value. Once entered into, the Deed is final and irrevocable and so it is vital that it is correct since you do not have a second bite of the cherry, especially where the intention was to save Tax and a mistake has arisen.
Following the Budget in July 2015, the HMRC carried out a consultation on the use of deeds of variation for tax purposes. It concluded that there was no evidence of abuse, although they would continue to monitor their use.
Professional executors are good at spotting tax planning opportunities and so be sure to talk to us about ways in which we can help reduce your exposure to Inheritance Tax.