What is it?
Inheritance Tax is usually paid on your estate when you die. Most estates don’t have to pay Inheritance Tax because they are valued at less than the threshold (£325,000 in 2009-10).
Give It Away And Live For 7 Years
No inheritance tax (IHT) is payable on most gifts in your lifetime so long as you live 7 years after the gift. These gifts are known as a Potentially Exempt Transfers (PET)
If a gift is made but there is some reservation on it, such as gifting your house with the understanding you can still live there until you die, this will not count as a PET and will still form part of your estate that is subject to IHT on at death. However, the gift will be effective for capital gains tax, which can create a double tax charge for the person that inherits the house.
If you give away cash that is used to purchase your house, you can be liable to income tax on the benefit of living in the house. This is called the pre-owned asset charge.
There is a sliding for scale for the amount of IHT payable for death within the 7 years. Of course if your estate is worth less than £325,000, no IHT is ever payable.
Other Gifts That Are Always Free Of Inheritance Tax
The following will always be free on IHT, whenever they are made…
- Small gifts to the same person of not more than £250 in a year.
- Gifts in consideration of marriage of £5,000 from parents, £2,500 from grandparents and £1,000 from anyone else.
- Normal expenditure out of income where the amounts given are part of your normal expenditure taking one year with another.
- Amounts up to £3,000, with any unused amount being allowed to be carried forward to the following tax year.
- Capital transfers for family maintenance – often connected with divorce.
- Any gifts between spouses/civil partners, where the person who receives the gift is domiciled in the UK.
- Any gifts to charities or political parties.
Husband and Wife (or civil partners)
No inheritance tax is payable on gifts between spouses or civil partners as long as both parties are domiciled in the UK. This is often used as a basic method of IHT avoidance. If the gift is a transfer to a foreign domiciled spouse it is only exempt up to £55,000.
With effect from 9th October 2007 spouses and civil partners will now be able to make full use of the nil rate band belonging to each spouse. This is retrospective and applies to anyone with a spouse or civil partner previously deceased. That gives a total inheritance tax exemption for a married couple of £650,000 (for 2009/10). The new rules allow any unused part of the nil rate band on the death of the first spouse or civil partner to be passed to the surviving spouse or civil partner for use on their death.
Say Fred dies on 1 October 2009 with an estate worth £650,000 and his wife did not use her nil rate band when she died previously, he now has the benefit of two nil rate bands totalling £650,000. Now Fred’s executors will pay no IHT at all. The amount of the nil rate band that can be transferred is the proportion of the nil rate band that was unused on the death of the first spouse or civil partner.
For example if on the first death, 50% of a 325K nil rate band was unused, if on the second death the nil rate band is 350K at that time, then 50% x £350K = £175K is available for use in addition to their own nil rate band. There is a maximum of an amount equal to the nil rate band in force at the time of the second death that can be used in addition. Therefore, it doesn’t matter how many ex-spouses or civil partners there are, it is not possible to have a total nil rate band of over 650K in 2009/10.