Learning how to calculate inheritance tax can be useful when it comes to inheritance tax planning and minimising any potential future tax bills. It is also essential to understand how to calculate inheritance tax when it comes to paying tax due to HMRC. However, it is important to be aware that inheritance tax rules are highly complicated and gathering complete information to produce an accurate calculation can be difficult at times. It is strongly recommended you seek professional advice before proceeding with calculating and/or paying any inheritance tax bill.
How much is the estate worth?
To calculate how much inheritance tax will be due on an estate you will first need to determine the overall market value of the estate in its entirety. This means calculating how much all the deceased’s belongings and possessions are worth. Whilst assets such as money in current accounts and saving accounts are easily quantifiable, other assets such as property, jewellery, cars, antiques etc will need formal valuations to determine their market value.
Formal valuations for anything over £1,500 will be required. Although documents from the formal valuation are not submitted to HMRC when it comes to reporting and paying for inheritance tax, you must still retain all records. This is because HMRC have the power to investigate into inheritance tax affairs up to 20 years after inheritance tax has been paid.
Are there any outstanding debts?
You next need to ascertain if there is any outstanding individual debt owed by the deceased. This can include credit card bills, mortgage payments, overdrafts, or any other debt. Joint debt, as opposed to individual debt, is where a loan is taken out together with one or more other people. If there is joint debt, this will usually be transferred to the surviving people and does not need to be repaid from the deceased’s estate
Any individual debt, however, must be repaid in full from the estate first before any inheritance tax is paid. If there are insufficient funds from the estate to clear all debt, then debts will be repaid in priority order until all assets or funds have been exhausted. Once there is no estate left, all other debts will be written off. Debts of a deceased will never fall onto other people unless the individual provided a personal guarantee on the loan.
Can you use any inheritance tax relief options?
Certain types of assets within an estate may qualify for specific tax relief available to inheritance tax. The agricultural relief for inheritance tax allows for some agricultural property to be passed on inheritance tax-free. It applies to land or pasture that is used to grow crops or to rear animals intensively, but it does not include farm equipment and machinery, derelict buildings, livestock or harvested crops. To qualify, the property must be owned and occupied for agricultural purposes immediately before transfer for 2 years if occupied by the owner, or 7 years if occupied by someone else. Depending on which qualifying conditions are met, agricultural relief is available at 50% or 100% of the asset.
Other types of assets which qualify for inheritance tax relief include businesses. Where the deceased owned their own business, or had an interest in a business (such as investing or loaning to a business but was not a shareholder), or had shares in an unlisted business, such assets may qualify for 100% deduction through business relief. A 50% rate is available where the deceased owned shares controlling more than 50% of voting rights in a listed company; land, buildings or machinery owned by the deceased but were used in a business they were a partner in; or land, buildings or machinery used in a business and held in trust that the business had a right to benefit from. To qualify for business relief, the deceased must have owned these business assets for at least 2 years before their death.
It is not possible to claim for agricultural relief and business relief on the same assets. However, it may be possible for a farming business to utilise business relief on assets which are not applicable under agricultural relief such as for machinery.
Were any gifts given 7 years prior to death?
When calculating how much inheritance tax is due on an estate, it is necessary to also account for gifts which were made within 7 years prior to the deceased’s passing. Gifts are considered to be anything of value including cash, property or possessions. Certain gifts are exempt such as:
- Christmas and birthday gifts, or other gifts which are usually paid through your normal income.
- Gifts which fall into your annual exemption – this is £3,000 worth of gifts per tax year. This annual exemption can be carried forward to the following year, but only for one year.
- Wedding or civil ceremony gifts up to £1,000 per person that is unrelated to you, or £2,500 for a grandchild or great-grandchild, or £5,000 for a child.
- Any payments made towards supporting another person’s living costs such as an elderly relative where you may be paying for their care home costs or a child under 18 such as school fees.
- Any gifts to UK registered charities as previously mentioned.
- Small gifts of up to £250 per person, per tax year, so long as they have not received any other gifts that qualify as an exemption from this list.
For any other gifts which were given during the 7 years prior to death, there is a sliding scale on how much inheritance tax will apply. This is known as ‘taper relief’ and is calculated as follows:
- Gifts which were made less than 3 years prior to death – 40%
- Gifts made between 3 to 4 years prior to death – 32%
- Gifts made between 4 to 5 years prior to death – 24%
- Gifts made between 5 to 6 years prior to death – 16%
- Gifts made between 6 to 7 years prior to death – 8%
- Gifts made over 7 years prior to death – 0%
It is important to understand that the responsibility of paying any inheritance tax due on gifts falls upon the recipient of the gift and not the deceased’s estate. In practice however, it is not uncommon that a recipient of a gift is also the executor or administrator who is dealing with the estate. In this case, they may well choose to use any assets in the estate to pay off the inheritance tax due on gifts they have received.
What inheritance tax thresholds are available?
When all of the above information has been collated, the total value for the estate will be established. The next step will be to determine if any amount of it is liable to inheritance tax. This is done by comparing the estate to the available inheritance tax thresholds applicable for the deceased.
Every individual is entitled to the nil rate band (NRB) of £325,000. They are further entitled to a second inheritance tax threshold known as the residence nil rate band (RNRB) of £175,000 if their estate includes their main residence which is passed to a child or grandchild. Furthermore, where there in any unused inheritance tax thresholds from a late spouse or civil partner, any remaining amount is passed on to the surviving spouse or partner. This means the maximum inheritance tax threshold available to an individual is up to £1 million.
The availability of the RNRB can potentially be reduced or removed altogether where the total value of an estate reaches over £2 million. The RNRB threshold becomes tapered away depending on how much over £2 million the estate is valued at. This is explained in more detail under the ‘Will I have to pay inheritance tax?’ section on our article on How to Pay Inheritance Tax.
Inheritance tax at a rate of 40% becomes applicable upon an estate once it exceeds the available thresholds. Here is an example to illustrate how to calculate inheritance tax:
Mr Jones is unmarried and has an estate worth £400,000 which includes his main residence. He has never been married or been in a civil partnership. He leaves his home which is worth £350,000 to his adopted son. In addition to his estate at the time of death, he previously gifted his sister £180,000 6 years before his death and gifted his brother £50,000 4 years before his death. He has no other gift exemptions or tax relief available. This brings the total value of his estate to £630,000.
His estate can first be reduced by the RNRB of £175,000 because he has left his £350,000 home to a direct descendent. This threshold can only ever be deducted against the value of his home and therefore leaves a remaining value of £175,000 on the property. This can be cleared down completely using the NRB and leaves a remaining £150,000 available to be used against what is remaining in the estate.
The remaining £150,000 from the NRB will be applied against the gift of £180,000 made to Mr Jones’ sister. The NRB will always be applied to the main residence first where the RNRB does not eliminate the tax liability, and then applied to gifts before any remaining assets within the estate. Furthermore, when using the NRB to offset against gifts, it must be applied in order of when the earliest gift was made. This means it cannot be used to clear the gift of £50,000 made to Mr Jones’ brother.
As only £150,000 can be deducted from the £180,000 gift, the £30,000 remaining will be subject to inheritance tax at a rate of 8%. Mr Jones’ sister is therefore liable to pay £2,400 in inheritance tax. There is no more inheritance tax threshold available to reduce the estate down any further. Mr Jones’ brother is therefore subject to inheritance tax at a rate of 24% on his £50,000 gift. He will need to pay £12,000. The £50,000 left in the late Mr Jones’ estate will be charged at the regular 40% inheritance tax rate and is therefore due to pay £20,000.
For assistance with calculating inheritance tax due to be paid to HMRC please get in touch using the contact form below. You can also find further information on our website regarding how to pay inheritance tax to HMRC.