Inheritance tax – How to declare and who pays

By Kim Jarvis, Canada Life

In this article we look at which forms personal representatives (PRs) need to complete and who actually pays the tax.

To recap, under current rules, any part of the estate that falls within the available nil-rate band (NRB), currently £325,000, is taxed at zero. Anything in excess of the NRB is taxed at 40 per cent.

If any inheritance tax (IHT) is due, it is normally payable six months after the end of the month in which death occurred. For example, if death occurs in February 2017, any IHT due should be paid on or before 31 August 2017.

Any IHT liability must be paid before the grant of representation (known as confirmation in Scotland) can be obtained, so the PRs must ensure that there are sufficient funds available to meet this liability. Remember that no assets can be released from the estate until the grant is obtained.

Tax forms

When applying for the grant, the PRs must complete and send the appropriate tax forms. Which tax forms they should complete depends on whether there is an IHT liability.

Where IHT is payable

  • If the value of the estate exceeds the available NRB, the PRs need to complete IHT400 (C1 in Scotland) and submit this together with any supporting documentation.
  • IHT421 needs to be completed if any assets in the deceased’s estate will become the property of the PRs to distribute among the beneficiaries.
  • IHT402 is used if the PRs have any unused NRB to transfer from the deceased’s spouse or civil partner who died before them. PRs must apply to transfer any unused NRB before 24 months from the end of the month in which the deceased died. Where IHT has already been paid the PRs may receive a refund.
  • IHT403 provides HM Revenue & Customs (HMRC) with details of gifting and must be completed when the deceased made lifetime gifts within seven years of their death.
  • Where the deceased held assets jointly, IHT404 will need to be completed. Where land and buildings are owned in joint names, the deeds to the property will usually set out the share of each owner. But, as with other assets, each owner’s share will usually correspond to their contribution to the asset. Where the deceased’s share does not correspond to their contribution, they will need to explain why the deceased’s share is different.
  • In some circumstances, where the deceased was a member of the armed forces, certain associated services or emergency services and their death was caused by injury or disease suffered while on active service, an exemption to IHT may apply. A reduced IHT400 can be delivered to HMRC.

Where IHT is not payable

  • Where the value of the estate is below the NRB (either £325,000 or £650,000 if the PRs have made a claim to transfer any unused NRB using IHT217) or £1m and there is no IHT to pay because of the spouse, civil partner or charity exemption, the PRs need to complete IHT205 (C5 in Scotland).
  • IHT205 guides the PRs through the calculations and tells them when they should be completing form IHT400 instead if it appears that the estate is over the available NRB.

Paying the IHT

Any IHT due must be paid by the end of the sixth month after the deceased’s death. In some cases, however, such as where the estate consists mainly of property, it is possible to arrange to pay the IHT in instalments over a period of up to 10 years. Delaying payment can be costly because penalties and interest will be charged on the amount of IHT that should have been paid.

Before paying any IHT, the PRs need to obtain an IHT reference number from HMRC. The reference number, which can be applied for online via HMRC’s website or by post using IHT422, needs to be obtained at least three weeks before a payment is made.

Remember it is not possible to take money out of the estate, except for funeral expenses, until the grant is obtained. As the probate (confirmation) will not be granted until all dues and taxes, including IHT, have been paid or a payment plan agreed, you may be wondering how the PRs find the funds to meet any liability.

It may be that there are insufficient funds available in the estate to pay the IHT and PRs may have to pay the IHT from their own bank account or a joint bank account that they held with the deceased. If a PR pays it from their own bank account, they can claim the money back from the deceased’s estate or the beneficiaries once the grant has been obtained.

Banks, building societies and insurance companies will sometimes release money direct to HMRC when IHT is payable, so it may be worth the PRs approaching them if sufficient funds are held in cash or investments.

If the PRs cannot meet the IHT liability, they may have to sell a property from the estate to generate the cash. In that situation the PRs may have to borrow money (for example, by way of a bridging loan) to settle the tax and then, when the grant is obtained, reclaim the loan out of the estate before they distribute. An alternative might be to donate works of art. Families can donate pre-eminent works of art to the nation and receive a credit for the value of the item against IHT. Recently the Arts Council accepted a portrait of the 5th Earl of Carlisle by Joshua Reynolds from the Howard family of Castle Howard, Yorkshire, in settlement of £4.7m in tax.

Some estates can take years to settle and, as the IHT is due within six months, the PRs may not know the exact bill. In this instance they can make payments on account and, when the IHT is finalised, HMRC will refund any overpaid ‘on account' payments plus interest.

Some gifts, known as potentially exempt transfers (PETs), may become chargeable to IHT if the donor dies within seven years of making the gift. Where tax is due on a failed PET, it is the person who received the gift who must pay the tax, but remember they may be able to benefit from taper relief. If the person receiving the gift can't or will not pay, the amount due then comes out of the deceased’s estate.

Once the grant has been obtained the PRs can round up all the assets, pay off any debts including any tax and distribute the estate in accordance with the deceased’s will or the rules of intestacy.

Kim Jarvis is technical manager with Canada Life’s ican Technical Services Team.

Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland.