How Does Inheritance Tax Work?

HM Revenue and Customs collected more in inheritance tax last year than even before, collecting a total of £5.2 billion altogether.

Each fiscal year, usually in the March but also in the Autumn budget, rules are included to change how this structure works, and it is therefore important as a priority for anyone thinking about leaving a legacy.

Inheritance tax changed in the 2015 budget, to allow people to pass on more to children and grand-children without being taxed.

A new limit was introduced in April 2016, which will eventually allow each individual to pass on estates valuing up to £500,000 tax free, and couples up to £1 million.

Both married couples and civil partners are treated as individuals, each allowed to pass on their full allowance.

Inheritance tax can be very complicated, but below are some of the more simple rules, which will assist in understanding the inheritance tax situation.

Each individual is taxed at a rate of 40% on all their assets above a threshold. At the moment this threshold is £325,000, but from April 2017 a new higher threshold, including a ‘family home’ allowance began to be phased in.

The 2015 budget introduced the new provisions, allowing married couples to pass on their main home with added protection from the tax man.

At present the allowance stands at £125,000 increasing to £150,000 in 2019-2020, and finally to £175,000 in 2020-2021. This means that married couples will eventually be able to pass on estates worth up to £1 million to their heirs.

There is a catch, and that catch is that this total must include a ‘family home’, which must be the main property, and the property must pass to a direct descendant.

Buy to let and second properties will add to the total size of the estate as in a normal case.

Estates over £2 million loose the relief at £1 in every £2 over the threshold. Your estate will have no ‘family home’ allowance at all if worth over £2.2 million.

We are often asked, what will happen should we sell our main home and downsize?

People who sell an expensive property will be eligible for ‘inheritance tax credit’, so can still qualify for the new threshold, as long as most of the estate is left to descendants.

Recent changes are helping to bring down the costs for all the estate sizes including family homes. Small estates are still exempt from inheritance tax, and larger estates worth £1 million, that include family homes will have up to £140,000 extra tax-free allowance by the time the full home allowance is completely phased in.

It should be noted however, that the additional allowance will be gradually withdrawn for properties worth more than £2 million.

For advice on IHT planning, please contact us.