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Guide to inheritance tax

Introduction

Inheritance tax, or IHT, is a levy on assets left behind by a deceased person to his or her estate.

IHT is often referred to as a "voluntary" tax, in that you don't need to pay it if you are careful. Yet bereaved relatives still pour £3.6bn or more into the Treasury's coffers each year.

How is IHT levied?

Calculating IHT is simple – value all the assets that are left behind on death, add them up, knock off £312,000 (the "nil rate band" from 6 April 2007, increasing by £25,000 for each of the next two years) and tax what's left at 40 per cent.

To arrive at this sum you have to go through a fairly complicated procedure, called applying for “probate” from a court. This involves presenting a set of accounts in which all assets have been carefully added up. Any liabilities are then subtracted, leaving a final amount to be assessed by the Inland Revenue.

Is IHT a problem?

Yes and no. Accountants argue that if a person plans his or her estate properly, then the final bill can be reduced significantly and, in some cases, cut virtually to nothing.

The government argues that barely 5 or 6 per cent of all estates were subject to IHT.

However, back in 1997 only 500,000 households came under the IHT net. As property prices have increased, more than five million households face the prospect of IHT being levied when the homeowner finally dies.

Moreover, the government’s figures are slightly disingenuous: they are based on the – admittedly correct – assumption that the assets of a person who dies will be passed on to the surviving spouse. But all it does is delay the moment at which IHT is paid until that person dies.

How much of a slice can the taxman demand?

Say an estate is worth £1m after all expenses are paid, the total tax take would be £275,200.

To arrive at this figure, deduct £312,000 from the £1m figure. Your taxable estate would be £688,000, of which 40 per cent is lopped off in IHT.

So how can you cut this bill?

1) Make a will

The first step is to make sure you have a proper will.

This is not just for peace-of-mind reasons: apart from anything else, if you are co-habiting, your partner is not automatically entitled to any part of your estate. More importantly, a will is the key mechanism for reducing tax payable after death.

The next question is what kind of will. Many couples have their wills structured so that all assets are passed to the surviving spouse, who is automatically not liable to pay IHT. But when the surviving spouse dies, the taxman will be back.


More pages

Page 1: Introduction
Page 2: 2) Use a trust within a will

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