Liability for Tax

Inheritance Tax is one of the most feared and yet least planned-for forms of taxation in the UK. Forward thinking is imperative if you are to ensure that your dependants’ finances are not aversely affected by Inheritance Tax (IHT) and so it is important to know whether or not you are likely to be liable to pay it.

The Estate

Inheritance Tax is paid on the total value of the estate of a deceased individual. The term ‘estate’ refers to almost everything owned by that individual at the time of death, although there are some exemptions. Furthermore, some gifts made within a certain time period before death will also be liable for IHT. However, not everyone pays IHT; rather, an individual’s liability for IHT will depend on the total value of their estate on death.

For this tax year (2011-2012), the Inheritance Tax threshold is set at £325,000. If the total value of your estate exceeds this figure, you will be liable to pay the tax. This £325,000 threshold is known as the nil-rate band, and is the non-taxable allowance available to everyone. However, any amount above this band will be subject to IHT. Currently this means that 40% of your estate will pass to the Exchequer if you have made no mitigating provisions.

Mitigating your Liability

There are a number of exceptions, which may lead to the lessening of your Inheritance Tax liability. In the first instance, it is important to remember that there is no tax payable on transfers of assets between spouses or civil partners, regardless of the total value of the estate. This essentially means that an individual can give their entire estate to their spouse or civil partner tax-free, which is a frequent occurrence. However, this is not necessarily the most tax-efficient method of asset transfer as it only makes use of one of the couple’s nil-rate bands. More information on tax-efficient ways of passing assets between spouses and civil partners, see our article Distribution of the Estate in this section.

There are several other ways in which you can limit your liability for Inheritance Tax. As well as the nil-rate band, everyone is granted a £3,000 annual limit on tax-free gifts, meaning that you can give away assets worth up to £3,000 each year without incurring any Inheritance Tax. Furthermore, allowances are made for wedding and civil partnership gifts up to a value of £5,000, as well as gifts to charity with no upper limit. Finally, anything that is given away more than seven years before the death of the individual in question will be exempt from IHT.

The valuation of an estate for the purposes of establishing its Inheritance Tax liability must be carried out in a specific way. The most important aspect to remember is that the personal representative (that is, the individual who has been asked to handle the deceased individual’s affairs) must ensure that the value of the estate is judged as if it were going to be sold on the open market at the time that the individual died. More information on estate valuation can be found in article Valuation of Your Estate