Inheritance tax

Introduction to Inheritance tax

Inheritance tax (IHT), introduced in the 1986 Finance Act and governed by the Inheritance Tax Act of 1984, replaced the Capital Transfer Tax and Estate Duty. IHT accounts for around £5.5 billion of government revenue, with only 4%-5% of estates paying it, thanks to various reliefs and tax planning strategies. Despite ongoing discussions, the IHT rules have remained largely unchanged since the mid-1980s.

What is inheritance tax?

Inheritance tax in the UK is a 40% tax on estates valued over £325,000, based on the total value of assets like property, investments, and life insurance payouts. There’s no tax if the estate is under this threshold, or if assets above £325,000 are left to a spouse, civil partner, charity, or community sports club. The threshold can be increased to £500,000 if a home is passed to children.

Who must pay inheritance tax?

Inheritance tax must be paid by the beneficiaries of an estate if its value exceeds the threshold and it is not exempt.

Beneficiaries of estates valued over the IHT threshold (£325,000 or £500,000 for homes passed to children)
Estates where the assets are not passed to a spouse, civil partner, charity, or community sports club
Individuals inheriting from an estate with significant assets or exceeding the exemptions

PET- Potential Exempt Transfers

A Potentially Exempt Transfer (PET) is a concept within UK inheritance tax law that allows individuals to make gifts during their lifetime without immediately incurring inheritance tax, provided certain conditions are met. If the donor survives for at least seven years after making the gift, the transfer becomes fully exempt from inheritance tax, regardless of its value. However, if the donor passes away within seven years, the gift is included in their estate for inheritance tax purposes. The amount of tax due on a PET decreases on a sliding scale known as “taper relief” if the donor survives for more than three but less than seven years. PETs are often used as a tax-efficient way to pass wealth to beneficiaries during one’s lifetime, particularly when combined with strategic financial planning to minimize the overall tax burden on the estate. Common examples include gifts to individuals or trusts that do not fall into the category of immediately chargeable lifetime transfers.

CLT – Chargeable Lifetime Transfer

A Chargeable Lifetime Transfer (CLT) is a gift made during a person’s lifetime that may be subject to inheritance tax if its value exceeds the annual exemption limit. CLTs are typically used when an individual transfers assets, such as property or cash, to others while still alive, and the value of the transfer is above the £325,000 threshold. If the value of the CLT exceeds the nil rate band, it could be subject to a 20% inheritance tax charge at the time of transfer, with potential additional tax if the donor passes away within seven years. CLTs are often a part of estate planning strategies to reduce potential IHT liabilities.

Probate

Probate is the legal process of administering a deceased person’s estate, including validating their will (if one exists) and distributing assets to beneficiaries. It involves valuing the estate, which determines whether inheritance tax (IHT) is payable. If the estate’s value exceeds the IHT threshold, the tax must be paid before probate can be granted, allowing the executor to access and distribute the assets.

How we as Tax Advisers can help?

Estate Planning: Advise on structuring assets to minimize inheritance tax (IHT).
Tax Reliefs: Identify and apply for exemptions like the Nil Rate Band or Business Relief.
Lifetime Gifts: Guide on using Chargeable Lifetime Transfers (CLTs) and Potentially Exempt Transfers (PETs).
Valuation Assistance: Help accurately value the estate to determine IHT liability.
Compliance: Ensure accurate IHT returns and timely payments.
Trust Management: Advise on setting up trusts to reduce IHT exposure.
Wealth Transfer Strategies: Create plans for tax-efficient inheritance and asset distribution.

What has changed in Budget 2024 – IHT and the changes made involving AGR (Agricultural Property Relief) and BPR (Business Property Relief)

In past trading businesses used to received 100% BPR relief on the death estate which protect the business from undue taxes on the death of the individual, but Chancellor has recently updated inheritance tax (IHT) rules, highlighted in the UK’s Autumn 2024 Budget. Starting in April 2025, Agricultural Property Relief (APR) will extend to include land used for government-backed environmental initiatives like conservation and regenerative agriculture, encouraging sustainable practices. However, from 6 April 2026, relief caps will change: the current 100% relief on agricultural and business assets will apply only to the first £1 million. For assets exceeding this threshold, relief drops to 50%, with the remainder potentially subject to IHT at an effective rate of 20%.

These reforms aim to balance fiscal needs with support for small estates, ensuring most family farms remain protected. Yet, they pose challenges for larger estates, particularly as unlisted business shares will also see reduced relief from 100% to 50%. Farmers and business owners are urged to review succession plans, wills, and asset structures to mitigate potential tax burdens.

Example – applies the new changes of IHT into an easy-to-read scenario

Mr A owns shares in the family trading company, which fully qualify for BPR, worth £3m for IHT purposes. If Mr A dies on or before 5 April 2026, then no IHT will be due on these, irrespective of to whom he leaves them under his will. If Mr A dies on or after 6 April 2026, assuming his nil rate band has been used on other assets, his estate will have an IHT liability of £400,000. Had the shareholding been owned by the husband and wife, with them both dying on or after 6 April 2026, the liability would have been reduced to £200,000 as two £1m bands would be available.

How might the reforms affect trusts?

These changes will affect trustees of trusts that own assets that qualify for BPR and APR. Trustees will need to assess their exposure to IHT in the event of the trust IHT 10-year charge and IHT charges in respect of trust capital distributions. There will also be an impact on any assets held in qualifying income in possession trusts ‘QIIP’ (where the assets are treated as part of the estate of the life tenant). A charge to tax may arise for trustees on the death of the life tenant or where the QIIP otherwise comes to an end.

Trustees with a 10-year charge date (or exit charge date) that falls before 6 April 2026 will calculate their IHT exposure under the current rules.

So, the impact of the proposed new reforms will affect the IHT due in respect of the first IHT 10-year charge (and exit charges) that falls on or after 6 April 2026. It remains to be seen how new legislation will proscribe how that first 10-year charge calculation factoring in the new regime for BPR/APR assets will be done. The content of the promised technical consultation in early 2025 will be the first opportunity to see how such important new practical issues might be addressed by the Government.

What’s next?

After a prolonged period of speculation about IHT changes, we now have some clarity. With 18 months before the proposed BPR/APR reforms come into force, taxpayers should start assessing the impact of the proposals on their plans for succession. But each taxpayer will be in a different position and so it is important that appropriate advice is taken before taking any action in response to the proposed reforms.

Matters to consider would include:

Are you impacted: are you in scope of IHT, do you qualify for BPR or APR, do you have any related loans?
What will the likely IHT exposure be?
How would it best be funded?
Is there action to take? and
When should those actions be taken?

It would be easy to forget when considering these matters that BPR and APR remain extremely valuable and if you are unsure whether your assets qualify it will be worthwhile evaluating this.

Please get in touch with the authors or your usual WIM Tax Specialists to discuss further.

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