When someone dies, all their belongings and wealth become what is known and referred to as their ‘estate’. Some examples of assets that become a part of someone’s estate include:
- Property, such as their main residence, but also any investment property they may own
- Cash in bank accounts including ISAs and stocks and bonds accounts
- Any other investments or shares which may be paying dividends
- Private pension funds
- Money paid out on life insurance policies
- Family heirlooms as well as other personal possessions such as the deceased’s cars or jewellery
Inheritance tax may be due on an estate and so it is important to understand how you know if any inheritance tax will be due, how to calculate how much, and how to go about paying inheritance tax if applicable.
What is inheritance tax?
Inheritance tax is a specific form of tax which is charged on the value of an estate once someone dies. It is one of the most controversial and unpopular forms of taxation in the UK. Critics argue that individuals would have been paying the relevant taxes throughout their lifetime on earnings and gains, so to be taxed again upon death would mean unfair double taxation. Others, however, support inheritance tax and see it as a mechanism to redistribute wealth amongst the whole of society as opposed to keeping it in affluent families.
Inheritance tax is charged at the standard rate of 40%. It is applicable on any value that falls above the inheritance tax thresholds. It means that tax is charged on the value of the deceased’s possessions. It is not a tax that is charged against beneficiaries who may be inheriting any assets as is commonly misunderstood. Beneficiaries may be taxed on any assets inherited at a later date such as when they dispose of assets and may incur capital gains tax.
Will I have to pay inheritance tax?
You only have to pay inheritance tax on your estate when the total value falls over the inheritance tax thresholds:
- The nil rate band (NRB) of £325,000
- The residence nil rate band (RNRB) of £175,000
This means only the value over £325,000 may be liable to inheritance tax at 40%. Where your estate also includes your main residence which you pass onto your children or grandchildren (including adopted, foster and stepchildren), then you are able to take advantage of a second and separate threshold known as the RNRB. Any family home worth £175,000 or under will not be subject to inheritance tax so long as it is passed to direct descendants. Any remaining amount can be absorbed by the NRB so a total of £500,000 can be left to beneficiaries tax-free.
However, the exception to this is if the total value of your estate reaches £2 million before any applicable tax relief has been deducted. Once your estate goes over £2 million, you begin to lose £1 from your RNRB for every £2 over £2 million. In practice, your entire RNRB allowance will be tapered away where your estate is worth £2.35 million or more. It is important to note that this only impacts your RNRB and your NRB remains unaffected.
When do you not have to pay inheritance tax?
You do not need to pay inheritance tax where your entire estate falls under the NRB and the RNRB. In fact, for the tax year 2017/18 it was reported that only 3.9% of UK deaths resulted in an inheritance tax charge. This was a decrease from the previous year and likely to be due to the introduction of the RNRB in April 2017. This means that only a small minority of individuals in the UK will be affected by inheritance tax charges.
Your estate is also exempt from inheritance tax on anything that is left to your spouse or civil partner. Not only that, but where there is any unused amount from your NRB or RNRB, this allowance is passed onto them. Therefore, the maximum a surviving spouse or civil partner can have in their estate without incurring inheritance tax is £1 million (this is the combined total of the NRB and RNRB for both individuals).
Any assets which are left to registered charities are free from inheritance tax charges. There is no maximum amount which can be left to charities. Furthermore, where at least 10% of your total estate is donated to charity, all other assets left to other beneficiaries will be charged at a reduced rate. This may be a consideration well worth taking when it comes to inheritance tax planning.
How to calculate inheritance tax
Before you will be able to calculate how much inheritance tax is due on an estate, you will first need to determine the total value of the estate and find out if there are any outstanding debts to be paid. All debts solely owed by the deceased must be paid in full from the estate first before calculating inheritance tax. Further deductions or tax relief may be applicable to reduce down the estate. For more details you can follow our step-by-step guide on how to calculate inheritance tax.
How to pay inheritance tax
To be able to pay inheritance tax due on an estate you will first need to obtain an inheritance tax payment reference number from HMRC at least 3 weeks before you make payment. You can apply for one online or by completing the form IHT422 and posting it back to HMRC. When you receive the inheritance tax payment reference number, you will need to use it as the reference alongside payment.
You can use online banking or telephone banking to pay for inheritance tax. HMRC bank details for inheritance tax can be found here. You can also pay direct at a bank or building society by using the payslip HMRC provides if you requested the inheritance tax payment reference number through using the form IHT422. Previously, you could also pay via cheque, however this method is currently suspended due to the Coronavirus.
You can pay for the inheritance tax due on an estate using your own personal funds and then claim this amount back from the estate. Or, if you have controlling access to the deceased’s bank accounts or share a joint bank account with them, you can pay direct through these accounts.
Where you are unable to pay the entire sum of inheritance tax due because assets such as property need to be sold first, you can enter into a yearly instalment plan. This will allow you to pay in equal instalments over a maximum of 10 years. If you plan to do this, you will need to inform HMRC ahead of time via the form IHT422. You also need to be aware that HMRC will charge interest on your instalments.
Deadlines, when to pay inheritance tax by, and fines if you are late
There are two deadlines to be aware of when it comes to inheritance tax:
- You are obliged to report and complete inheritance tax forms to HMRC within one year of death
- You are required to pay inheritance tax within 6 months of death
This means that you are able to begin paying for inheritance tax even before you have finished formally valuing all of the assets within an estate. Any late filing will result in an initial £100 fine. Late filing made between 6 months and 12 months after when they were due will receive a further £100 fine. If late filing exceed 12 months after they were due, then up to £3,200 can be issued as a penalty. For late payment, HMRC will begin charging interest on inheritance tax due at a rate of 2.6%.
However, where late fines have been paid and inheritance forms have been submitted after to declare no inheritance tax is due on the estate, the fines will be repaid by HMRC. If there is inheritance tax due, but it is less than the amount paid in fines, a rebate for the difference will be issued. The maximum fine for when late filing has been submitted up to 12 months after the due date cannot exceed the tax owed.
Where possible, most people will prefer to pay inheritance tax early in order to avoid accruing interest. This may mean paying an estimate of the inheritance tax due before all valuations have been completed and this is referred to as ‘payment on account’. If you have overpaid the actual amount of inheritance tax due, HMRC will provide a refund as well as pay you interest on the overpayment.
For help with calculating or paying inheritance tax to HMRC, please get in touch using the contact form below.