Inheritance Tax – The Death Estate 24th July 2015

Posted in: Inheritance Tax

In this post, I will talk about inheritance tax in relation to the death estate. When a taxpayer dies there are 3 potential charges to inheritance tax that can result:

  • potentially exempt transfers (PETs) become chargeable if made in the 7 years prior to death
  • chargeable lifetime transfers (CLTs) may incur extra tax if made in the 7 years prior to death
  • the death estate will become chargeable to inheritance tax (although that charge may be zero, as a result of the nil rate band)

PETs and CLTs were covered in an earlier post. In this post we will look at the death estate.

Before we can calculate any charge to inheritance tax, we must first value the deceased’s estate at the date of their death. There is no concept an exempt asset at this stage, all assets and liabilities must be reported to HMRC. We need the net value of all assets at the date of death – that is all assets less any debts or liabilities. Once we have the net assets figure, we can then remove exempt items in order to calculate the inheritance tax due.

Assets are typically valued at their open market value, so the value of the deceased’s home would be the market value, less any outstanding mortgage.

One of the most common debts a taxpayer will have at death is unpaid income tax. The executors of the estate will have to prepare the income tax return to the date of death.

Reasonable funeral costs are an allowable deduction from the value of the estate.

The only other costs that are allowed are additional expenses of administering or realising property situated abroad e.g. the cost of obtaining foreign probate. However these costs are limited to a maximum of 5% of the value of the foreign assets.

If the taxpayer is not UK domiciled, then we can exclude non UK assets – these are known as ‘excluded property’.

Let’s look at an example.

James made a gift to his son of £180,000 (after annual exemptions) in June 2009. James died in February 2014. His death estate was valued at £900,000. In his will he left two thirds of his estate to his wife and the remaining third to his son.

The gift to the son in June 2009 is within 7 years of James’s death, but it is covered by the nil rate band of £325,000, so there is no inheritance tax (IHT) to pay on that transfer.

The tax on his death estate is as follows:

£ £
Value of estate at death 900,000
less: exempt transfer (2/3 to spouse) (600,000)
chargeable estate 300,000
nil rate band at death 325,000
less: transfers in previous 7 years (180,000)
Nil rate band remaining (145,000)
Taxable 155,000
IHT @ 40% 62,000

How dies the situation change if James had left his entire estate to his wife?

£ £
Value of estate at death 900,000
less: exempt transfers (900,000)
Chargeable estate 0
Nil rate band at death 325,000
less: transfers in previous 7 years (180,000)
Nil rate band remaining (145,000)
Taxable 0
IHT @ 40 % 0

In this case, there is no IHT to pay on death, however, see what has happened to the nil rate band. James had £325,000 at the time of his death, but the gift to his son a few years earlier has reduced what he has left to £145,000.

This remaining nil rate band can now be transferred to his wife. She now has an effective nil rate band of £470,000 (£325,000 + £145,000). However, let’s suppose that when James’s wife dies the nil rate band has moved from £325,000 to £500,000. What’s her nil rate band at death?

It’s £500,000 + [(£145,000 / £325,000) x £500,000] = £723,077

In other words, what was left of the nil rate band transferred from James has been uplifted to the rates prevailing at the time of her death.