This document is useful for anyone sitting the LPC Wills and Administration exam as a key topic is inheritance tax.
I achieved a high distinction in the exam due to the detail in these notes. They contain a step by step structure for tax calculations.
POINTS TO NOTE:
The aim of IHT is to impose a tax liability on estates at the time of death. So when a person
dies, IHT is levied on the wealth that they have accumulated during their life time.
Also, to avoid tax being avoided, IHT is also charged retrospectively on certain lifetime
transfers (transfers made during a person's lifetime).
HOW TO CALCULATE IHT: The procedure for calculating the tax liability is basically the same
whether dealing with a lifetime transfer or one on death.
STEP 1: identify the transfer of value:
The chargeable event for IHT is the making of a transfer of value, so first step is to
identify the value.
A transfer of value is a disposition which reduces the value of the transferor's estate
(aka a gift, it cannot be something you make profit on).
You are deemed to have made a gift when you die, and death is therefore a deemed
transfer of value.
Therefore, for IHT purposes, everything you were beneficially entitled to immediately
before death forms part of your death estate (house, car, cash in wallet, shares in joint
property etc).
HOWEVER, if you have beneficial entitlement (merely the trustee of a trust), you
would not have a beneficial entitlement to the trust property. It would fall outside the
death estate.
STEP 2: find the value transferred:
Need to put a monetary value on each asset that is being transferred.
For figure for the value transferred for the death estate = add the value of different
assets (then deduct) - (minus) any debts or liabilities owed by the deceased at the time
of his death, including reasonable funeral costs.
STEP 3: apply exemptions and reliefs:
The availability of these exemptions and reliefs depends either on the status of the
person to whom assets are being transferred or the nature of the assets themselves.
Types of exemptions (0 IHT NEEDS TO BE PAID)
Spouse exemptions = any gift to a spouse is completely exempt from IHT. HOWEVER,
this only applies to spouses and civil partner not co-habitees.
Gifts to charity = want to maximise the money that goes to charities and encourage
charitable giving, therefore gifts to charity is completely exempt from IHT.
Types of reliefs:
Business property relief = this is a relief not an exemption therefore provided that the
business satisfies certain conditions, there will be no tax or less tax to pay.
STEP 4: calculate tax at the appropriate rate:
This is to calculate the appropriate rate of tax once any exemptions or reliefs have
been taken off.
On death, there are two rate of tax (0% and 40%). A certain amount is taxed at 0% and
then the balance above that figure is taxed at 40%.
, Residential nil rate band
This will not apply to every estate, it will only apply if certain requirements are met.
Requirements = the estate includes a qualifying residential interest, basically the
estate includes an interest in property which was the deceased's home, which is being
closely inherited. Basically, it has to be inherited by a lineal descendent (including step-
child).
IMPORTANT: when considering an estate, need to watch out for is the deceased's
home being passed onto their children or grandchildren because that is when you take
into account the residence nil rate band.
EFFECT OF RESIDENTIAL NIL RATE BAND = first £175,000 taxed at 0%.
NOW CONSIDER:
Ordinary nil rate band
Universal application which applies to any estate (WILL APPLY IN EVERY SCENARIO).
EFFECT OF ORDINARY NIL RATE BAND = first £325,000 of the estate or the next
£325,000 of the estate(if residence nil rate band is taken into account) is taxed at 0%.
Once that is taken off, anything above that level is taxed at 40%.
IMPOTANT: IF RESIDENCE NIL RATE BAND AND/OR ORDINARY NIL RATE BAND ARENT USED,
THEY CAN BE PASSED ONTO SPOUSE OR CIVIL PARTNER.
SCENARIO: if a husband dies leaving all his estate to his wife, remember that any gift to a spouse is
completely exempt from IHT, so the husband won't have used his nil rate band. When the wife dies she'll
have her own nil rate band of £325,000 and her husband's because he didn't use it, so that's another
£325,000. Plus, provided she meets the requirements of passing her home onto her children, she'll also
have her own residence nil rate band and her husband's, so a grand total of £950,000 of her estate will be
taxed at 0%.
SCENARIO: Ben has died. At the time of his death Ben owns a house mortgage-free, worth
£500,000 and he has £100,000 in a bank account. In his will Ben gives £20,000 to charity and
leaves the rest of his estate to his brother. Ben's debts and funeral expenses come to
£5,000.
STEP 1: death is a deemed transfer of value
STEP 2: The death estate is everything to which the deceases was beneficially entitled
immediately before death. Ben's only assets were his house worth £500,000 and the cash in
his bank account of £100,000. This is a total of £600,000. From that we can deduct Ben's
debts and funeral expenses - which were £5,000 - leaving a total of £595,000.
STEP3: exemptions: In his will, Ben left £20,000 to charity, so that is going to fall within the
charity exemption as any gift to charity is totally exempt from IHT, so taking that off leaves
us with £575,000 to charge to tax.
STEP 4: residence nil rate band does not apply as although Ben's house is a qualifying
residential estate for the nil rate band, it is not being closely inherited by a lineal descendent
(child or grandchild). Under the terms of his will the house passes to Ben's brother and
that's not a lineal descendent. So the resident nil rate band won't apply.
The ordinary nil rate band would apply and therefore the effect of the nil rate band is to tax
the first £325,000 of Ben's estate at 0% (£575,000 - £325,000 = £250,000) The balance
above 325,000 (aka the remaining £250,000) will be taxed at the death rate of 40%, so the
IHT payable on the estate is (£250,000 x0.4 = £100,000) = £100,000.
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