Inheritance tax is a tax on paid on the estate – essentially the property, money and possessions – of someone who’s died.
The vast majority of the population do not pay inheritance tax at all because it’s only applied to estates over a certain threshold – the most recent statistics show less than 4 per cent of estates paid it in 2020–21 – but it’s still unpopular among voters, with a recent YouGov poll finding that just 20 per cent of people deem it a “fair” tax.
There have been reports in recent days that Chancellor Jeremy Hunt will scrap or reform the tax in the upcoming Budget, scheduled for the start of March.
Below, we run through how the tax works, and what changes to the rules could mean for those who pay it.
Who pays inheritance tax?
Inheritance tax is paid on the estate of someone who has passed away, with funds from the estate used to pay HM Revenue and Customs (HMRC). This is done by the person dealing with the estate.
Crucially, there’s normally no tax to pay as long as the value of the estate is below £325,000, or everything over this threshold that’s left to a spouse, civil partner, a charity or a community amateur sports club.
And if you give away your home, or “main residence” to your children – including adopted, foster or stepchildren or grandchildren – your threshold can increase to £500,000.
On top of this, if you’re married or in a civil partnership and your estate is worth less than your threshold, the unused threshold can be added to your partner’s threshold when you die, meaning they can end up having a threshold of up to £1m.
How much is inheritance tax?
The standard inheritance tax rate is 40 per cent and this is charged on the part of your estate that’s above the threshold.
This means that if your threshold is £325,000 and your estate is worth £400,000, you only pay 40 per cent on £75,000.
The estate can pay at a reduced rate of 36 per cent on some assets if it leaves 10 per cent or more of the “net value” to charity.
There are additional rules too. For example, the £175,000 extra allowance for your home only applies if the estate is worth less than £2m. On estates worth more than this, the allowance will decrease by £1 for every £2 above £2m that the estate is worth.
And there are also additional exemptions. For example, no tax is due on any gifts you give if you live for seven years after giving them – unless the gift is part of a trust.
You can also give away a total of £3,000 worth of gifts each tax year without them being added to the value of your estate, even if you do pass away within seven years.
There is a full list of rules and exemptions in our guide on how to avoid the tax trap.
What changes could we see to inheritance tax?
According to reports in The Telegraph, the Chancellor is considering scrapping the tax altogether in the Spring Budget, meaning it would not be owed on estates from now on.
Even if the tax is not scrapped altogether, there are other changes that campaigners have called for, which could be implemented.
The £325,000 tax-free threshold has not been increased for over a decade and some Conservative MPs have previously called for it to increase. This would mean that fewer estates would pay the tax, and those that did pay would do so on a smaller amount.
The proportion of deaths resulting in inheritance tax is set to grow to over 7 per cent by 2032–33, and a rise in the threshold could cut this number.