Reduce your IHT liability with the new 36% rate of IHT
From 6 April 2012 people who leave at least 10% of their net estate to charity can pay a reduced rate of Inheritance Tax (IHT) of 36% instead of 40%. This new relief is significant for anyone with an existing Will or anyone looking to make a new one. It is also significant for personal representatives administering an estate of a person who has died on or after 6 April 2012. How does the reduced rate work? The examples and table below show how leaving a gift to a charity in your Will can reduce your IHT liability. James died on 12 April 2012 with an estate worth £340,000 leaving everything to his children. His available IHT threshold was £325,000 (2012/13 tax year). IHT at 40% would be payable on £15,000 (£340,000 less £325,000) so £6,000. The children receive £334,000. Peter's position is exactly the same, except for the fact that he has left 4% of his net estate to charity in his Will. We use "net estate" to refer to the part of his estate that would be taxable but for charity relief. (The legacy to charity could be by way of a cash legacy, a gift of specific items or a share of residue.) The children would only receive £360 less than in the example above and £600 would pass to charity. Under the new rules, however, Peter can do much better. If instead he increases the charity legacy to 10% of his net estate, then the children still inherit the same amount, but the charity receives more and the Revenue takes the hit. The table below shows the IHT position for James and Peter, including where Peter gives 4% or 10% of his net estate.
| Impact of new 36% rate of IHT | |||||||||||||||||||
| James | Peter - 4% to charity | Peter -- 10% to charity | |||||||||||||||||
| Estate on death | £340,000 | £340,000 | £340,000 | ||||||||||||||||
| Less IHT threshold | £325,000 | £325,000 | £325,000 | ||||||||||||||||
| Net Estate | £15,000 | £15,000 | £15,000 | ||||||||||||||||
| Less charity legacy | £0 | £600 | £1,500 | ||||||||||||||||
| Taxable Estate (taxed at 40%) | £15,000 | £14,400 | |||||||||||||||||
| Taxable Estate (taxed at 36%) | £13,500 | ||||||||||||||||||
| HMRC receive | £6,000 | £5,760 | £4,860 | ||||||||||||||||
| Children receive | £334,000 | £333,640 | £333,640 | ||||||||||||||||
| Charity receive | £0 | £600 | £1,500 | ||||||||||||||||
The family members will always receive less as a result of the combined effect of the charity legacy and the tax, but the reduction in the rate of IHT should encourage charitable giving.
What happens if you do not have your full IHT threshold available?
The case studies assume that the full IHT threshold is available. If Peter had used up some or all of his IHT allowance then that would reduce the amount of the IHT threshold that could be deducted and increase the amount that would have to be given to the charity. For example, if Peter had given £150,000 to his daughter 4 years before he died then his IHT threshold would be £175,000 (£325,000 less £150,000) meaning that in order to satisfy the 10% threshold £16,500 (10% of £340,000 less £175,000) would need to be given to charity to qualify for the reduced rate.
What if you own assets jointly or are a beneficiary under a trust?
The position does get a little more complicated than the examples shown above, because as well as assets which a person owns in his own name or as tenants in common, a person's estate can also include jointly owned property and interests in certain types of trust and these will affect the tax payable. In that case the lower rate is available if 10% of your own net estate, ignoring the other components, is taxable.
You will also need to take into account exemptions and reliefs
The value of a person's estate is reduced by a number of reliefs and exemptions, such as spouse or civil partner exemption, business property relief, agricultural property relief etc. If after deducting the various reliefs and exemptions your net estate is below the IHT threshold then no IHT would be payable. It is only if, after reliefs and exemptions have been deducted the value of your net estate is over the IHT threshold, i.e. your estate is taxable, that the new rules will be advantageous to you.
Can you elect for the reduced rate not to apply?
The reduced rate of IHT will apply automatically if your estate or the component passes the 10% test. However, personal representatives can elect for the reduced rate not to apply if, for example, the benefit is likely to be minimal and the personal representatives will need to incur additional costs in valuing items left to charity to establish whether they qualify.
Do I need to change my Will?
If you have already made a Will which leaves some of your estate to charity you may wish to review this to check whether the legacy satisfies the 10% test and consider whether you want to increase the charitable legacy so that your estate can qualify for the reduced rate.
Varying a will after a death
If you are a personal representative of an estate where the deceased died on or after 6 April 2012 and did not include a charitable legacy in his Will, (the Mr Not-Give example) or where the legacy is not sufficient to meet the 10% test (the Mr Give 4% to charity example), then the beneficiary/ies may wish to consider varying the Will by entering into a Deed of Variation to make or increase a charitable legacy so that the estate can benefit from the reduced rate.
The IHT reduced rate calculator
HMRC has created an on-line charitable legacy calculator and this is available on their website http://www.hmrc.gov.uk/tools/iht-reduced-rate/index.htm which you may find useful if you are administering an estate with charitable gifts and want to work out whether the estate will qualify.