Inheritance Tax (Basics)

Inheritance tax (IHT) is a tax on the transfer of wealth. It applies primarily on death but can also arise on certain lifetime transfers.

Transfer of value: A transfer of value is any disposition made by a person that reduces the value of their estate. The most common transfers are: gifts (outright transfers to individuals or trusts) and the deemed transfer on death (the entire estate).

Two types of lifetime transfer:

Death estate: On death, the entire estate (all assets less liabilities) is deemed to be transferred and is charged to IHT at 40% on the amount exceeding the nil rate band.

The following transfers are exempt from IHT — they are not taxable regardless of amount or timing:

Order of applying exemptions: Exemptions are applied to reduce the value of the transfer before any tax calculation. The annual exemption is used first against CLTs (which are immediately chargeable), then against PETs (which are only chargeable if the donor dies within 7 years).

Nil rate band (NRB):

• The first £325,000 of chargeable transfers is taxed at 0% (effectively tax-free)
• The NRB is a cumulative lifetime allowance — it is used up by chargeable transfers (CLTs and failed PETs) made in the 7 years before the current transfer or death
• On death, the NRB available = £325,000 minus any NRB used by chargeable transfers in the 7 years before death

Transferable NRB: If a person's spouse/civil partner died before them and did not use all of their NRB, the unused proportion can be transferred to the surviving spouse's estate on their subsequent death. Maximum transferable: 100% of one NRB (£325,000). This means a married couple can have a combined NRB of up to £650,000.

Residence nil rate band (RNRB):

• An additional nil rate band of £175,000 (2024/25), available when a qualifying residential property (the family home) is left to direct descendants (children, grandchildren, including adopted and step-children)
• Also transferable between spouses — maximum combined RNRB of £350,000
• Tapered withdrawal: The RNRB is reduced by £1 for every £2 that the estate exceeds £2 million (fully withdrawn at estates of £2.35 million)
• The RNRB cannot exceed the value of the qualifying residential property left to direct descendants

Combined maximum nil rate bands for a married couple:

NRB: £325,000 × 2 = £650,000 + RNRB: £175,000 × 2 = £350,000 = £1,000,000 tax-free on the second death.

Taper relief reduces the amount of IHT (not the value of the transfer) on failed PETs and CLTs where the donor dies between 3 and 7 years after making the transfer.

Important: Taper relief reduces the TAX, not the value of the transfer. The transfer still uses up the NRB in full. Taper relief only applies if the transfer exceeds the NRB — if the transfer is within the NRB, no tax is due and taper relief is irrelevant.

BPR reduces the value of qualifying business property transferred for IHT purposes.

BPR rates:

Conditions:

• The property must have been owned for at least 2 years before the transfer (lifetime) or death
• The business must be a trading business (not mainly investment — e.g., a property investment company does not qualify)
• Excepted assets (assets not used wholly or mainly for the business) do not qualify for BPR

APR provides similar relief for agricultural property — land and buildings used for agricultural purposes. The relief rate is 100% (if the transferor had the right to vacant possession or the property was let on a farm business tenancy from 1 September 1995) or 50% (for other tenanted property). The property must have been owned and occupied for agricultural purposes for at least 2 years (if farmed by the owner) or 7 years (if let to a tenant farmer).

Effect of BPR/APR: The relief reduces the value of the transfer. For 100% relief, the business property is effectively IHT-free. For 50% relief, only half the value is chargeable.

Format:

Lifetime tax on a CLT:

1. Start with the gross value of the gift
2. Deduct available exemptions (annual exemption, etc.)
3. Deduct any BPR/APR
4. = Chargeable transfer
5. Deduct the NRB available at the date of the CLT (£325,000 minus CLTs in the previous 7 years)
6. Tax on the excess at 20% (lifetime rate)
7. If the donor pays the tax, the gift must be "grossed up" — the tax itself is a further transfer of value. Gross transfer = Net gift ÷ (1 − 20%) = Net gift ÷ 0.8 = Net gift × 100/80
8. If the donee (trustee) pays the tax, no grossing up is needed

Death tax on a failed PET or CLT (donor dies within 7 years):

1. Take the value of the transfer (as originally calculated, net of exemptions)
2. Apply the NRB at the death rate (£325,000) — deducting any NRB used by earlier chargeable transfers in the 7 years before the transfer
3. Tax at 40%
4. Apply taper relief if the donor survived 3–7 years
5. For CLTs: deduct lifetime tax already paid — the additional death tax is only the excess (if the recalculated death tax is less than or equal to the lifetime tax paid, no additional tax is due — but there is no refund of lifetime tax)

Cumulation: Transfers use up the NRB in chronological order. When calculating the NRB available for any transfer (lifetime or death), look back 7 years from the date of that transfer and deduct any chargeable transfers made in that 7-year window.