Do I have to pay tax on inheritance?

In this guide we will aim to demystify Inheritance Tax, explaining what it is, how it is calculated and some of the exemptions. 

It’s important to remember that tax thresholds, rules and allowances can change. It’s therefore always a good idea to speak with a professional or check the latest information on the government website for the latest up-to-date information regarding Inheritance Tax. 

What is Inheritance Tax, and how does it work?

Inheritance Tax is a tax on the estate of a person who has passed away. A person’s ‘estate’ includes their money, belongings, and property.

It’s the responsibility of the executor or administrator of the deceased's estate to make sure that any Inheritance Tax due is paid to Her Majesty’s Revenue & Customs (HMRC). 

Here's how Inheritance Tax works:

Calculate estate value: When someone dies, everything they own is added up, such as their house, savings, investments and physical possessions. Any debts, including overdrafts, loans, credit cards and mortgages, are then subtracted to get the final value of the estate. 

Gifts: If gifts were made less than seven years before death, Inheritance Tax may also be payable on these. The value of eligible gifts is included in the estate's total value for Inheritance Tax calculation purposes.

Exemption amount: If the assets are worth less than £325,000, no tax is due.

Taxable part: If your estate is worth more than the exemption amount, anything over £325,000 could be taxed at 40%.

Payment: Whoever is in charge of your estate after you're gone must calculate the tax and then pay any tax due to HMRC.

Exceptions: Some gifts, like presents given to your spouse or donations to charity, might not count for Inheritance Tax.

Are there any exemptions for Inheritance Tax?

Yes - there are a number of exemptions for Inheritance Tax, where no or less tax needs to be paid.

Here are some common exemptions and reliefs:

Spouse or civil partner exemption: Transfers of assets between spouses or civil partners are usually exempt from Inheritance Tax. 

Charitable donations exemption: If the deceased left at least 10% of their estate to charity in their will, the estate might qualify for a reduced rate of Inheritance Tax (36% instead of 40%) for any amount which exceeds £325,000. 

Agricultural property relief: If the deceased owned agricultural property, it may reduce the amount of Inheritance Tax you have to pay. 

Business property relief: If the deceased owned a business, business property relief might be applicable, reducing the value of the business property that's subject to Inheritance Tax.

Transfers to political parties: If the deceased made transfers to certain political parties, these transfers might be exempt from Inheritance Tax.

Small gifts exemption: You can give away up to £250 to as many unique individuals as you like without risking incurring inheritance tax if you pass away within seven years. Christmas or birthday presents you buy with your regular income are also exempt from Inheritance Tax.

Annual exemption: You can give away £3,000 each year without risking it being eligible for Inheritance Tax if you pass away within seven years.

Gifts for weddings and civil partnerships: For a wedding or civil partnership you can gift: up to £5,000 to a child, £2,500 to a grandchild or great-grandchild or £1,000 to any other person. This will not be eligible for Inheritance Tax if you pass away within seven years.

It’s important to remember that the details and eligibility criteria for these exemptions can be complex and subject to change. You may therefore want to consider speaking to a financial advisor. 

Do I need to pay tax on cash that I inherit?

Inheritance Tax is paid upfront from the estate before the assets and money are divided among the beneficiaries (the name for the people who will receive the inheritance). Therefore, you don’t normally have to pay tax on cash once you’ve inherited it. However, if you put it in a savings account, you may have to pay tax on any future interest earned. 

Whether the estate will be eligible for Inheritance Tax before your portion comes to you depends on a range of factors. If the overall value of the estate (including property, money, and belongings) is below £325,000, Inheritance Tax generally won’t be payable. That means you’ll receive your share of the total estate value, without any tax being deducted. 

It's important to remember that the tax is calculated based on the estate's total value, not the specific amount you’ll receive. Consider an example where your aunt passes away and wants to split their £500,000 estate between you and your 1 sibling. Even though the amount you are eligible to receive (£250,000) is below the £325,000 threshold, the combined estate value reaches £500,000. 

If there were no further exemptions, Inheritance Tax would be payable on £175,000 (£500,000 total minus £325,000 exemption) at 40%. This means a total of £70,000 would be paid in Inheritance Tax and the value of the estate post tax would drop to £430,000. Your share would therefore be £215,000.

Do I have to pay Inheritance Tax if I inherit our family home?

Whether you have to pay Inheritance Tax when inheriting a property depends on factors such as the value of the house, other assets in the deceased's estate, and your relationship to the deceased. 

If you inherit the house from your spouse or civil partner, there is usually no inheritance tax to pay, however much the estate is worth.

If you inherit a main residence and are a child or grandchild of the deceased, there is a "residence nil rate band" that can affect the tax calculation.
This exists to make it easier for families to pass on their main homes to their direct descendants without incurring as much Inheritance Tax. 

If you’re not a spouse, child or grandchild of the deceased and the total value of the estate, including the inherited house, exceeds the inheritance tax threshold, you might need to pay Inheritance Tax on the portion above that amount. 

Why does Inheritance Tax exist?

Inheritance Tax exists to create revenue for the government and support societal and economic goals.

Revenue generation: The primary reason for the existence of inheritance tax is to generate government revenue. Taxation is a significant source of income for the government to fund public services, such as education and the NHS. 

Wealth redistribution: Inheritance tax helps make wealth more equal by taking some of the wealth left by people who have died and sharing it with society. This stops wealth from gathering in just a few families and makes sure resources are spread more fairly.

Encouragement of charitable donations: Inheritance Tax exemptions for charitable donations encourages individuals to contribute to charitable causes, benefiting the broader community.

Opinions about supporting or disagreeing with paying Inheritance Tax vary among individuals. It's a debated topic because its outcomes are complex to grasp and talk about – they relate to money growth, fairness, and what benefits society, which are subjective. 

Can I give away my assets before I die to avoid my children having to pay inheritance tax?

It’s important to think carefully and do your research before trying to use a gifting strategy to reduce the potential Inheritance Tax on your estate. Some of the things you may want to consider include:

• Giving away assets more than seven years before you die usually means they're not counted for Inheritance Tax when you pass. Gifts made within seven years might still be considered.

• If you live between three and seven years after a gift, the tax on it might be reduced - this is known as taper relief. 

• You can gift £3,000 each year without it being subject to Inheritance Tax.

• Gifts to your spouse or civil partner aren’t usually subject to Inheritance Tax, regardless of when you give them.

However, this is a very simple overview. Inheritance Tax and gifting allowances are complicated and you may want to consider seeking professional advice, particularly if you have a large estate. 

How does HMRC know if my parent gave me money?

HMRC uses a combination of methods to identify gifts and cash transfers that might be subject to Inheritance Tax within the seven-year period before someone's death. These include: 

• Gift reporting: Executors of an estate are required to report any gifts made by the deceased within the seven years before their death on the Inheritance Tax forms. This information is then submitted as part of the tax calculation process.

• Bank records: HMRC has access to financial transactions. If there's a significant transfer of money between accounts, it could raise a flag. Large financial transactions are often monitored, and unusual patterns might be investigated.

• Estate valuation: When the estate is being valued for Inheritance Tax purposes, any large gifts or transfers made in the seven years prior to death are likely to be identified during the valuation process. HMRC has the authority to audit and investigate estates to ensure proper tax is paid. If they suspect undeclared gifts or transfers, they might dig deeper into financial records.

• Data sharing and technology: HMRC uses data analytics and technology to identify potential tax evasion.

It's important to understand that while HMRC has methods to identify gifts, the tax system also relies on individuals and their representatives to provide accurate information. 

Failure to report gifts within the seven-year period could lead to incorrect tax calculations, penalties, and potential legal issues. If you're unsure whether a gift needs to be reported or you have questions about Inheritance Tax, speak to a professional tax advisor or seek the support of Citizens Advice, which offer free general guidance on various legal and financial matters, including Inheritance Tax.