What is inheritance tax and are the rates changing?

The rules surrounding inheritance tax can be difficult to understand, with our guide you will be able to understand inheritance tax on a deeper level.

What is inheritance tax?

Inheritance tax is the tax on the estate of someone who dies. This includes all assets that are owned by the individual on death, including Property, Shares, Cash, Personal Effects etc

Typically, there is no inheritance tax to pay if:

The total value of your estate is below the £325,000 threshold (below 500K if you are leaving your main residence directly to children or grandchildren)
Everything above the £325,000 threshold is left to your spouse, civil partner, a charity or sports club.

Inheritance Tax is payable on an estate after deducting funeral costs, any debts on the estate such as loans and mortgages and the IHT threshold. Any remaining value is taxed at 40%.

What are the thresholds?

Each individual is entitled to a current threshold of £325,000 per person, this is called the Nil Rate Band. If you own a main residence and plan to leave this directly to children or grandchildren, then you are entitled to another £175K of Nil Rate Band, this is called the Main Residence Nil Rate Band. However, If your estate is over £2m, then the additional £175K threshold is reduced by £1 for every £2 over £2m.

If you leave everything to your spouse or civil partner, there is no inheritance tax payable, any unused nil rate band and main residence nil rate band can be transferred to the surviving spouse. This means the potential Inheritance Tax threshold on second death could be £1m.

Example

Mr A passes away and has an estate of £1m after funeral costs and debts on the estate. Part of his estate includes his 50% share of the main residence which is valued at £250K. He leaves everything to his wife.

There is no Inheritance Tax due as everything has been left to his wife. His wife will also inherit Mr A’s nil rate band of £325K and his main residence nil rate band of £175K.

Mrs A passes away a year later, providing there has been no increase in value of the assets, Mrs A will have a main residence in her estate of £500K and other assets of £1.5m. She leaves everything to the children. Mrs A’s threshold is £1m, therefore tax will be paid on the remaining 1m at 40%.

Are inheritance tax rules changing?

The chancellor has announced that the current nil rate band of £325K will remain frozen until at least 2026, the main residence nil rate band will also be frozen until 2026 also.

In March 2021, the government announced changes in Inheritance Tax that became effective in January 2022. HMRC are reducing the number of forms needed to be completed and will raise the current limits.

The new reporting requirements under the new legislation are as follows:

The IHT205 and IHT217 forms to be scrapped for all estates that are exempt
The spousal/civil partnership threshold will triple, increasing from £1 million to £3 million
If the deceased held assets within a trust, the limit of the value of those assets being held will increase from £150,000 to £250,000 per trust.
If the deceased made lifetime gifts within 7 years before their passing, the value that the gifts cannot exceed is being increased from £150,000 to £250,000

The estate of anyone who dies on or after 1 January 2022, will be affected by these changes if their estate is low value or exempt estates.

In addition to these changes, HMRC has also defined the definition of spouses and civil partners. The following are considered spouses under inheritance tax laws:

People legally married to each other, including same-sex couples
People who are legally registered as civil partners
People who are legally married but only separated by death
People within a valid polygamous marriage

Are any assets exempt from inheritance tax?

Certain business assets can qualify for either 100% or 50% Business Asset Relief, these include shares in unlisted trading companies or business assets such as plant and machinery, land or buildings. Relief will be given at either 100% or 50% depending upon the nature of the asset.

Main Residence Nil Rate Band

The government states that only ‘direct descendants’ of people who have died can benefit from the main residence nil-band rate.

The nil-band rate is also known as the ‘main residence’ band. This is an additional £175,000 allowance you will receive on top of the £325,000 inheritance tax allowance if you pass on the estate to your children or grandchildren.

Direct descendants are considered: