Inheritance Tax: An opportunity for the next UK government to reform?
By Chris Campbell, Head of Tax (Tax Practice and Owner Managed Business Taxes)
29 May 2024
As the UK general election approaches, we look at some of the present challenges surrounding inheritance tax and the potential opportunities for reform for any incoming government.
Despite a welcome extension to agricultural property relief in the Chancellor’s spring Budget, there’s been minimal reference to inheritance tax in recent fiscal events, other than to freeze thresholds. Inheritance tax can be complex to understand and we believe the Chancellor missed an opportunity in recent Budgets to simplify the system.
The nil rate band
Tax is payable on the estate of someone who’s died, this also applies to gifts, in the seven years up to their death. Most estates in the UK don’t pay inheritance tax, as assets are covered by the nil rate band (NRB) (currently £325,000) or other tax reliefs, like agricultural property relief or business property relief.
There are exemptions for anything left to your spouse or civil partner (provided they live permanently in the UK). Exemptions also apply to charity and community amateur sports clubs. Tying in with the current election campaign, it’s worth noting that gifts made to most political parties are exempt from inheritance tax.
It’s important to remember that if an individual leaves at least 10% of their net estate to charity, the inheritance tax rate is reduced from 40% to 36%.
Residence nil rate band
Survivors can also benefit from the additional residence nil rate band of up to £175,000. This comes into effect when someone passes on the family home upon death. For example, if a married couple or a civil partnership couple were to combine both the nil rate band and the residence nil rate band, they may benefit from a combined nil rate band of £1 million after the surviving spouse dies.
However, there are several conditions to qualify for the residence nil rate band, including leaving the family home to children, grandchildren or even great grandchildren (this includes stepchildren). The way the rules are structured means that anyone who doesn’t have children can't access the residence nil rate band. Similarly, two siblings sharing a house will be unable to access the additional relief. This could result in the survivor being forced to sell their home after the first death. We believe that the Chancellor missed another opportunity to simplify this system in the 2024 spring Budget. Merging the nil rate band and residence nil rate band would mean it’s no longer necessary for an estate to include a residence being left to a direct descendant to qualify for a combined nil rate band of £500,000 (£1 million per couple).
The need for reform
As both thresholds have been frozen for several years, more estates are now subject to inheritance tax due to increased property values (particularly in the South of England, but other areas including Edinburgh have also seen a significant rise in property value). In addition to the rate bands, people can also benefit from the annual exemption (£3,000 per tax year), small gifts exemption (gifts up to £250) and exemption for gifts in consideration of marriage or civil partnership (£5,000 from the parent of either party to the marriage or civil partnership, £2,500 for one of the parties to the marriage or civil partnership, or their grandparent or remoter ancestor or £1,000 in any other case, depending on the identity of the transferor) It may surprise you to learn that annual exemption has remained at £3,000 since 1981. We hope that the next incoming government will look at merging the exemptions into one simple (but higher) exemption, making it easier for people understand and comply with.
As the various thresholds and exemptions have remained frozen for as much as 43 years, and are expected to be frozen until 2028, families who previously haven’t had to consider the possibility of being within the scope of inheritance tax, may now find themselves having to take action to avoid a potential tax liability. Many people will start the process of passing wealth to the next generation in their lifetime, in the hope that the gift will be outside the seven-year window in the event of their death. In other cases, individuals will accept that they have an inheritance tax exposure but take out insurance to pay for the expected tax liability on their death as their wealth increase.
Circumstances will vary between families, therefore it’s important to obtain professional advice, as estate planning can be a complicated exercise. Remember that the best course of action for one family may not be appropriate for another.
Let us know your views
We welcome your views, which help inform our work on consultations or other tax-related matters. ICAS responds to many tax calls for evidence and consultations, as well as producing tax policy papers and reports. We also regularly attend meetings with HMRC at which service levels, delays and other issues are discussed, and we raise problems being encountered by members.
Please email tax@icas.com to share your insights and feedback.
