Comprehensive Guide Inheritance Tax For Individuals and Businesses

Death and taxes are the two certainties in life – we all know the phrase! And with the former comes Inheritance Tax (IHT), which unironically underlines its relevance. 

Many people find inheritance tax confusing and intimidating. But the good news is that most UK people don’t have to pay it. 

In fact, less than 4% of estates paid IHT in 20-21, though this is expected to climb to 7% and higher in the years ahead.  

In any case, you’re probably more likely to pay IHT if you don’t understand how it works and the reliefs available, so having a solid grasp of the key principles is essential. 

Even if you don’t think IHT would apply to your estate now, it could in the future. 

To assist, this guide describes exactly how inheritance tax works, including the latest thresholds, available exemptions, and strategies to ensure your assets are passed on as efficiently as possible.

By the time you reach the end, you’ll be armed with the knowledge needed to make informed decisions and safeguard your hard-earned wealth for future generations.

Understanding the Fundamentals of Inheritance Tax

Inheritance tax, often abbreviated to IHT, is a levy charged on the estate (property, money, and possessions) of someone who has died. 

The tax is paid before the assets can be distributed to the beneficiaries named in the deceased’s will or in accordance with the rules of intestacy.

The current standard IHT rate in the UK is 40%, but this is only payable on the portion of the estate that exceeds the available nil-rate band (NRB) thresholds. 

These thresholds are the amount of the estate that is exempt from IHT, and they are as follows:

• Individual Nil-Rate Band: £325,000
• Residential Nil-Rate Band: An additional £175,000 if the estate includes a residential property left to direct descendants (e.g., children or grandchildren)

So, for example, if the value of an individual’s estate is £500,000, and they are able to utilise both the individual and residential nil-rate bands, the amount subject to IHT would be £500,000 – £325,000 – £175,000 = £0. 

Transferring the Nil-Rate Band

One key advantage in inheritance tax planning is the ability to transfer the nil-rate band between spouses or civil partners. 

When the first spouse or civil partner passes away, any unused portion of their £325,000 individual nil-rate band can be transferred to the surviving spouse or partner.

This means that if the first person to die had used none of their nil-rate band, the surviving spouse or partner would have a total nil-rate band of £650,000 (£325,000 x 2) to apply against their estate.

Additionally, the residential nil-rate band of £175,000 can also be transferred between spouses and civil partners. 

So the total potential nil-rate band for a married couple or civil partners can be as high as £1 million (£325,000 x 2 + £175,000 x 2). So, in this case, £1 million can be passed on to children or grandchildren tax-free.

Spouses and Inheritance Tax

When one spouse or civil partner passes away, their entire estate can be transferred to the surviving partner free from inheritance tax (IHT) under the spousal exemption, provided both individuals are UK-domiciled. 

This means the surviving spouse does not have to pay any IHT on what they inherit, no matter how large the estate is.

If one spouse is non-domiciled in the UK, however, the spousal exemption is limited to £325,000. Any amount above this threshold that is transferred to the non-domiciled spouse may be subject to IHT. 

To avoid this, the non-domiciled spouse can be treated as UK-domiciled for tax purposes, allowing them to inherit the full estate without paying IHT. 

However, this election means the non-domiciled spouse will be subject to UK tax on their worldwide estate.

Gifts Between Spouses

In addition to the spousal exemption at death, gifts between spouses or civil partners during their lifetime are also exempt from IHT.

This means you can give your spouse or civil partner unlimited gifts of money, property, or other assets during your lifetime without these gifts being counted toward the value of your estate for IHT purposes. 

However, this rule applies as long as both partners are UK-domiciled. If one spouse is non-domiciled, the same £325,000 cap applies to lifetime gifts as it does for inheritance. 

Gifts exceeding this threshold may be subject to IHT unless the non-domiciled spouse opts to be treated as UK-domiciled for tax purposes.

Other Key IHT Exemptions and Reliefs

While inheritance tax may seem like an unavoidable burden, some several exemptions and reliefs can help minimise your liability:

1. Gifts: Certain gifts made during the deceased’s lifetime, such as those below the annual £3,000 exemption or those made more than seven years before their death, may be exempt from IHT.
2. Charitable Donations: Gifts to qualifying charities, political parties, and certain other organisations are exempt from inheritance tax.
3. Business Property Relief: Business assets, including shares in a private limited company, may be eligible for up to 100% relief from IHT, provided certain conditions are met. This can be particularly beneficial for business owners transitioning their company to the next generation.
4. Agricultural Property Relief: Agricultural land and property can qualify for up to 100% relief from IHT, again subject to meeting specific criteria. This can be a valuable exemption for those with farming or rural estates.
5. Exemption for Regular Gifts out of Income: Payments made from your regular surplus income, rather than your capital, may be exempt from IHT if certain conditions are met. This can be a useful way to gradually reduce the value of your estate over time.

Understanding these exemptions and how they may apply to your specific circumstances is crucial for effective inheritance tax planning.

Strategies for Minimising IHT Liability

Alongside taking advantage of the available exemptions, there are several proactive strategies you can employ to reduce your inheritance tax exposure:

1. Lifetime Gifts: Making gifts during your lifetime, particularly those that fall within the annual exemption or survive for at least seven years, can help reduce the value of your estate and the subsequent IHT bill. This could include outright gifts, gifts into trust, or the use of discounted gift schemes.
2. Trusts: Establishing trusts, such as a discretionary trust, a life interest trust, or a bereaved minor’s trust, can enable you to pass on assets while retaining a degree of control and potentially mitigating IHT. Trusts can be particularly useful for protecting assets for younger beneficiaries or placing restrictions on how the assets are used.
3. Pension Planning: Ensuring your pension arrangements are structured in a tax-efficient manner can help shield your assets from inheritance tax. This involves maximising contributions to pensions, using pension death benefits to fund life insurance policies, or considering using spousal bypass trusts.
4. Life Insurance: Investing in a life insurance policy written in trust can provide a tax-free lump sum payment to your beneficiaries upon your passing, helping to offset any IHT liability.
5. Business Succession Planning: For business owners, carefully planning the transfer of your company to the next generation can unlock valuable reliefs and exemptions, such as Business Property Relief. This may involve introducing a Family Investment Company, Employee Ownership Trusts, or other structures to facilitate a smooth transition.

More About Business Relief (BR) for Inheritance Tax

One of the most valuable IHT reliefs available is Business Relief (BR), also named Business Property Relief (BPR).

This relief can vastly reduce the inheritance tax liability for business owners and their families by lowering the taxable value of a business or its assets.

The premise behind BR is straightforward. It recognises the importance of allowing the transfer of family businesses to the next generation without unduly eroding their value through taxes. 

By providing generous relief rates of up to 100%, BPR aims to encourage entrepreneurship and the continuation of trading enterprises.

What Qualifies for 100% BPR? 

You can get 100% Business Property Relief on:

• The entire value of a business or an interest in a business.
• Shares in an unlisted company.

This means that if the deceased owned a qualifying business or shares, 100% of the value of those assets can be deducted from their estate for inheritance tax purposes.

50% Business Property Relief 

In addition to the 100% relief, you can also claim 50% Business Property Relief on:

• Shares controlling more than 50% of the voting rights in a listed company.
• Land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled.
• Land, buildings or machinery used in the business and held in a trust that the business has the right to benefit from.

The key requirement for both the 100% and 50% relief is that the deceased must have owned the business asset for at least two years before they died.

Restrictions on BPR 

There are some important restrictions on what qualifies for Business Property Relief:

• Companies that mainly deal in investments, securities, stocks, shares, land or buildings cannot claim the relief.
• Companies that are not-for-profit organisations do not qualify.
• Assets that also qualify for Agricultural Relief cannot also get Business Property Relief.
• If the business is being sold or wound up, the relief may not apply (unless it’s part of a process to allow the business to continue).
• The asset must have been used mainly for business purposes in the 2 years before being passed on.

The rules around BR can be complex, so seeking professional advice is important to ensure you’re claiming the maximum relief possible.

Proposed Changes to Inheritance Tax in 2025 And Beyond

As the new Labour government takes power, there is increasing discussion about potential changes to the UK’s inheritance tax (IHT) system. Although the party’s manifesto focused mainly on stopping the use of offshore trusts to avoid IHT, the government has now revealed more detailed plans for reform.

One of the most notable changes is the proposed abolition of the non-domiciled (non-dom) tax status, set to be replaced with a residence-based system starting from 6 April 2025.

Non-dom status allows UK residents who are not permanently settled (domiciled) in the UK to avoid paying UK tax on foreign income and gains, as long as they don’t bring those assets into the UK. 

Under the proposed new system, tax will be based on where someone lives rather than their domicile status.

For new arrivals, a four-year grace period would still apply, meaning they won’t have to pay tax on foreign income or gains for the first four years. However, excluded property trusts – a tool that allowed assets held in trusts outside the UK to avoid IHT – will no longer be an option.

In addition to non-dom changes, the government is exploring several other potential reforms:

• Business Property Relief (BPR) reform: The current 100% IHT relief on trading business interests held for over two years could be restricted, particularly for “investment” activities such as AIM-listed stocks.
• Elimination of the “double benefit”: Currently, assets can benefit from both BPR and a capital gains tax uplift upon death. The government may consider removing one of these advantages, viewing the combination as overly generous.
• Pension fund inclusion: There are rumours that pension funds might be included in a person’s taxable estate on death, or a new “pension nil-rate band” could be introduced, limiting the amount that can be passed on tax-free.
• Lifetime gifts regime overhaul: The current seven-year period for potentially exempt transfers could be replaced with a tax charge on lifetime gifts, possibly at 10% above an annual allowance of £30,000.

Any changes are expected to occur after a full consultation period, allowing taxpayers time to adjust their plans. 

However, those with business interests reliant on existing reliefs, or those considering passing on wealth through lifetime gifts, may want to act sooner rather than later to avoid potential impacts from these reforms.

Wrapping Up

It can be confusing once you dive into the nuances of IHT, especially Business Relief and other lesser-known reliefs. These are particularly relevant to high-net-worth individuals and business owners. 

At Double Point, our team of chartered accountants specialises in providing comprehensive IHT solutions tailored for anyone from business owners to high-net-worth individuals and families. 

We closely monitor legislation, ensuring you remain compliant and can take advantage of the latest tax-saving opportunities.

So, whether you’re a business owner looking to transition your company, a high-earner seeking to protect your wealth, or an individual wanting to secure a lasting legacy for your family, don’t hesitate to contact us for help.