Inheritance Tax on lifetime transfers and transfers on death...

Learning Outcomes

This article explains how the nil rate band (NRB) and the different Inheritance Tax (IHT) rates apply to both lifetime transfers and transfers on death in typical SQE1-style problems. It outlines the distinction between potentially exempt transfers (PETs) and lifetime chargeable transfers (LCTs), including when each is chargeable, which rate (20%, 25%, 40% or 36%) is used, and how to identify the person primarily liable for any tax. It details the chronological allocation of the NRB to lifetime transfers and the death estate, the computation of cumulative totals over seven years, and the impact of earlier LCTs on later failed PETs (the so‑called 14‑year interaction). It reviews the operation, transferability and limitations of the NRB and the residence nil rate band (RNRB), and examines when taper relief reduces tax rather than the value of a gift. It also analyzes when the reduced 36% death rate for charitable giving applies, presents the key timelines for when IHT becomes payable and when the instalment option can be used, and highlights how these rules feed into clear, accurate exam calculations.

SQE1 Syllabus

For SQE1, you are required to understand the operation of Inheritance Tax on lifetime gifts and on death, with a particular focus on nil rate bands, tax rates, and the sequence in which they are applied, with a focus on the following syllabus points:

• the definition and application of the nil rate band (NRB) for IHT
• how the NRB is allocated between lifetime transfers and the death estate
• the distinction between potentially exempt transfers (PETs) and lifetime chargeable transfers (LCTs)
• the calculation of IHT at lifetime and death rates, including the effect of taper relief
• the rules for transferring unused NRB between spouses or civil partners
• the operation and tapering of the residence nil rate band (RNRB)
• the order in which transfers are taxed and the impact on IHT liability
• the 36% reduced death rate where at least 10% of the baseline amount passes to charity
• how cumulative transfers are computed, including interaction between PETs and earlier LCTs
• liability to pay IHT on PETs, LCTs and on death, due dates and the instalment option

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the current nil rate band for Inheritance Tax, and how is it applied when there are both lifetime gifts and a death estate?
2. How does taper relief affect the IHT payable on a PET made four years before death?
3. What is the difference between a potentially exempt transfer (PET) and a lifetime chargeable transfer (LCT) for IHT purposes?
4. How can the unused nil rate band of a deceased spouse be used by the surviving spouse's estate?

Introduction

Inheritance Tax (IHT) is charged on the value of a person’s estate on death and on certain gifts made during their lifetime. The nil rate band (NRB) and the applicable tax rates are central to calculating IHT liability. For SQE1, you must be able to apply the NRB and tax rates correctly to both lifetime transfers and transfers on death, and understand how these interact with exemptions, reliefs, and the order of taxation. It is also essential to track cumulative transfers over the seven years before each relevant transfer, to distinguish between when the lifetime 20%/25% rates or the death rates apply, and to recognise when special rates and reliefs—such as the residence nil rate band (RNRB) and the reduced 36% rate for charitable legacies—are available.

Key Term: nil rate band (NRB)
The maximum amount that can be transferred (either during lifetime or on death) without incurring IHT. The NRB is currently £325,000.

Key Term: chargeable transfer
A transfer of value that is not exempt from IHT and is therefore potentially subject to tax.

The Nil Rate Band (NRB)

The nil rate band is the threshold up to which no IHT is payable. For the 2023/24 tax year, the NRB is £325,000 and is fixed until at least April 2026.

The NRB is used in chronological order against chargeable transfers made in the seven years before death (including PETs that become chargeable and LCTs), and any unused NRB is then applied to the death estate. The NRB is cumulative, meaning earlier chargeable transfers reduce the amount of NRB available for later transfers within the same seven‑year window.

Key Term: cumulative total
The total value of chargeable transfers made by a transferor within the seven years before a particular transfer (or death), after taking account of any exemptions and relevant reliefs. It is used to determine how much NRB remains for the current transfer.

Practical points:

• NRB is a band taxed at 0%—it is not an exemption. It is allocated first to earlier chargeable transfers (in time order) and only then to the death estate.
• Lifetime-only exemptions (such as the £3,000 annual exemption and small gift exemption) are deducted before determining the value that uses the NRB.
• The RNRB does not affect the NRB available for lifetime gifts, and it is only relevant on death if conditions are satisfied.

Order of Application

When calculating IHT, the NRB is allocated first to the earliest chargeable transfer within the seven years before death, then to subsequent transfers, and finally to the death estate. This order is critical for determining how much of the estate is subject to IHT.

Where transfers occur on the same day, the legislation contains rules for apportionment and ordering. For exam purposes, ensure you:

• apply the NRB chronologically across chargeable transfers in the last seven years; and
• then apply any remaining NRB to the death estate.

Transferability of the NRB

If a person dies without using all of their NRB (for example, because their estate passes to a spouse or civil partner, which is exempt), the unused percentage can be transferred to the surviving spouse or civil partner and applied to their estate on death.

Key Term: transferable nil rate band
The proportion of the NRB unused on the first death can be claimed and added to the survivor’s NRB on their death.

Key points on transferability:

• The uplift is calculated as a percentage of the first spouse’s NRB that was unused, applied to the NRB in force at the survivor’s death.
• The uplift is capped at 100%. A surviving spouse who has been widowed more than once may aggregate unused percentages, but the total uplift cannot exceed 100%.
• The transferred NRB is available on the survivor’s death for death tax and any tax on failed PETs/LCTs associated with that death, but it is not available to reduce lifetime charges arising on LCTs made by the survivor during life.

Example in outline: If Spouse A left everything to Spouse B, A used 0% of their NRB. On B’s subsequent death, B’s estate may claim a 100% NRB uplift (two full NRBs at the rates prevailing on B’s death), provided a claim is made by B’s personal representatives. This increased NRB can then be used against tax on failed PETs, chargeable LCTs within seven years, and the free estate.

Types of Lifetime Transfers

IHT distinguishes between two main types of lifetime transfers: potentially exempt transfers (PETs) and lifetime chargeable transfers (LCTs).

Key Term: potentially exempt transfer (PET)
A gift made by an individual to another individual (not to a trust or company) that is exempt from IHT if the donor survives seven years. (Certain gifts into disabled person’s trusts can also be PETs.)

Key Term: lifetime chargeable transfer (LCT)
A gift made during lifetime that is immediately chargeable to IHT, typically gifts to most trusts or companies.

Common lifetime exemptions that reduce the value of a transfer before considering NRB include:

• annual exemption of £3,000 per tax year (with one year’s carry‑forward if unused in the immediately preceding year)
• small gifts up to £250 per recipient per tax year (cannot be combined with the annual exemption for the same recipient)
• normal expenditure out of income (regular gifts made from surplus income without reducing the donor’s normal standard of living)
• marriage/civil partnership gifts within specified limits
• gifts to spouses/civil partners (subject to special rules where the recipient is non‑UK domiciled) and to charities

The calculation of the value transferred is based on loss to the donor’s estate, not necessarily the asset’s own market value in isolation (e.g., part of a matched set may have a higher combined value than the sum of the parts).

PETs

• No IHT is payable at the time of the gift.
• If the donor survives seven years, the gift is exempt.
• If the donor dies within seven years, the PET becomes chargeable and is taxed using the NRB and rates in force at death, with taper relief possibly reducing the tax (but only if the PET gives rise to tax).

A PET that becomes chargeable because the donor dies within seven years is brought into the cumulative total to determine how much NRB is left for the estate.

LCTs

• IHT is payable at the time of the gift if the value exceeds the available NRB.
• The lifetime rate is 20% if the donee (e.g., trustees) pays the tax or 25% if the donor pays (grossing‑up).
• If the donor dies within seven years, additional IHT may be due to bring the total tax up to the death rate (40%), with taper relief potentially reducing the recalculated death tax. Any lifetime tax already paid is credited against the recalculated liability.
• The uplifted NRB from a predeceased spouse does not reduce lifetime tax on an LCT when it is made, though it may reduce death tax if the donor dies within seven years.

Practical point: The small gifts exemption does not apply to LCTs. The annual exemption can be used against LCTs.

Tax Rates

There are two main IHT rates:

• 20%: The lifetime rate, applied to LCTs above the NRB (or 25% if the donor pays, because of grossing‑up).
• 40%: The death rate, applied to the value of the estate (and chargeable transfers) above the NRB.

If 10% or more of the net estate is left to charity, a reduced death rate of 36% applies to the chargeable estate.

Key Term: taper relief
A reduction in the IHT payable on gifts made between three and seven years before death. It does not reduce the value of the gift, only the tax due.

Key Term: baseline amount
For the charitable reduced rate test, the amount on which the 10% threshold is measured: the net value of the estate component after deducting reliefs, exemptions and the available NRB, but before deducting the charitable legacy itself. The residence nil rate band is ignored for this computation.

Notes on the 36% rate:

• The 10% test is applied by reference to defined estate components (e.g., general component, survivorship component, settled property component). In many exam‑style problems, only the general component is relevant.
• Personal representatives can opt to merge components to meet the 10% threshold where this yields a better outcome overall.
• The RNRB is ignored when calculating the baseline amount but remains available in the substantive IHT calculation.

Taper Relief

Taper relief reduces the IHT payable on chargeable transfers (PETs or LCTs) made more than three years but less than seven years before death. The relief is applied as follows:

Taper relief applies only to the tax due, not to the value of the gift. It only benefits gifts that actually give rise to tax (i.e., the portion of the transfer falling above the available NRB). If a PET falls wholly within the remaining NRB at death, there is no tax on that PET and taper relief is irrelevant.

Worked Example 1.1

A donor makes a PET of £400,000 four years before death. The NRB is already used up. What is the IHT payable if the donor dies four years after the gift?

Answer:
The IHT at 40% on £400,000 is £160,000. Taper relief at 60% reduces the tax by £96,000 (60% of £160,000), so the IHT payable is £64,000.

Additional illustration (no tax to taper): If a PET of £100,000 is made five years before death and there is £150,000 of NRB still available at death, no tax arises on that PET and taper relief has no application even though the gift was made more than three years before death.

The Residence Nil Rate Band (RNRB)

An additional nil rate band applies when a residence is left to direct descendants (children, grandchildren, etc.). For 2023/24, the RNRB is up to £175,000. The RNRB is tapered away for estates over £2 million, reducing by £1 for every £2 above this threshold. It is separate from (and in addition to) the standard NRB.

Key Term: residence nil rate band (RNRB)
An additional threshold (currently up to £175,000) available when a home is left to direct descendants.

Key Term: closely inherited
For RNRB purposes, the residence (or its qualifying proceeds) must pass to a lineal descendant (including step‑children, adopted and children in care) or their spouses/civil partners, outright or on certain permitted trusts.

Key features:

• The RNRB is capped at the value of the qualifying residence (net of any mortgage secured on it).
• It applies only on death (not to lifetime gifts).
• It is applied before the standard NRB when computing the death estate tax.
• It can be transferred between spouses/civil partners if unused on the first death, increasing the RNRB available to the survivor’s estate (subject to the taper where the survivor’s estate exceeds £2 million).
• RNRB is not reduced by lifetime chargeable transfers and is ignored when computing the 10% charitable baseline amount.

Downsizing and the RNRB

If the deceased sold or downsized their home after 8 July 2015, the RNRB may still be available if assets of equivalent value are left to direct descendants. This “downsizing addition” preserves RNRB where a former main residence has been sold, provided the estate passes sufficient value to direct descendants.

Worked Example 1.2

An estate is worth £2.3 million, including a residence valued at £700,000. What is the available RNRB?

Answer:
The estate exceeds the £2 million taper threshold by £300,000. The RNRB is reduced by £150,000 (£300,000 ÷ 2), leaving £25,000 (£175,000 – £150,000) available.

Practical ordering:

• Apply the RNRB first (up to its cap and after taper).
• Then apply the standard NRB (including any transferable NRB).
• Then tax the remainder at 40% (or 36% if the reduced rate applies).

Sequence of Taxation

When a person dies, the calculation of IHT follows a strict order:

1. Identify all chargeable transfers (PETs and LCTs) made in the seven years before death.
2. Apply the NRB to the earliest transfer, then to subsequent transfers, and finally to the death estate.
3. Calculate IHT at the appropriate rate (lifetime or death rate).
4. Apply taper relief to chargeable transfers made more than three years before death.
5. Apply the RNRB if the residence passes to direct descendants.

Further sequencing and interaction issues to understand:

• A PET that becomes chargeable has its own seven‑year cumulation period, which may pull an earlier LCT (made within seven years before that PET) into account for cumulation when recalculating death tax. This is sometimes described as a 14‑year interaction, though the LCT itself will not be re‑charged to tax if it was made more than seven years before death; it can still affect the NRB available for failed PETs.
• For LCTs made within seven years of death, recalculate the tax at death rates, apply taper relief, and then give credit for any lifetime tax already paid.
• The 36% reduced rate for charitable giving is considered by reference to the baseline amount (after reliefs and NRB but ignoring RNRB and before deducting the charitable gift itself).

Worked Example 1.3

A person makes a LCT of £300,000 to a trust in 2017, a PET of £200,000 to a child in 2019, and dies in 2023 leaving an estate of £500,000. What is the IHT position?

Answer:
The LCT uses £300,000 of the NRB, leaving £25,000. The PET uses the remaining £25,000 of the NRB, so £175,000 of the PET is taxable. The estate receives no NRB. The LCT is taxed at 20% when made; if the donor dies within seven years, additional tax is due to bring the total up to 40%. The PET and the estate are taxed at 40%. Taper relief may apply to the LCT and PET depending on the time between the gift and death.

Worked Example 1.4

In March 2019, D made an LCT of £350,000 into a discretionary trust. D had made no earlier chargeable transfers in the preceding seven years. Assume the annual exemption of £3,000 was available for 2018/19 and carried forward from 2017/18.

Calculate: (a) any lifetime tax due in 2019; (b) the additional tax if D dies in April 2023.

Answer:
(a) Value transferred after annual exemptions = £350,000 − £6,000 = £344,000. NRB available = £325,000, so £19,000 is chargeable at the lifetime rate. If the trustees pay, tax is 20% × £19,000 = £3,800.
(b) On death within four years, recalculate at death rates: 40% × £19,000 = £7,600. Apply taper relief for 4–5 years: 60% × £7,600 = £4,560. Credit the lifetime tax paid (£3,800), leaving further tax of £760 payable by the trustees.

Worked Example 1.5

E made two PETs: £150,000 on 1 December 2018 and £250,000 on 1 June 2020. E dies on 1 August 2023 leaving an estate of £600,000 including a residence of £400,000 passing to E’s children. No earlier chargeable transfers. Assume both annual exemptions (£3,000) are available for the two most recent tax years for each gift.

Answer:
PET1 (2018): Value after annual exemptions = £150,000 − £6,000 = £144,000.
PET2 (2020): Value after annual exemptions = £250,000 − £6,000 = £244,000.
Cumulation at death: apply NRB (£325,000) chronologically. PET1 uses £144,000, leaving £181,000. PET2 uses £181,000 at 0% and leaves £63,000 over the NRB, taxed at 40% = £25,200. Taper relief applies (between 3 and 4 years): 80% × £25,200 = £20,160, payable by the donee of PET2. PET1 produces no tax and taper is irrelevant to PET1.
Death estate: The RNRB of £175,000 is available (residence to direct descendants, no taper as estate is below £2m). The standard NRB is fully used by the PETs, so none remains for the estate. Tax on the estate: (£600,000 − £175,000) × 40% = £170,000.

Worked Example 1.6

F makes no lifetime gifts. On death, F’s estate is £500,000 with a pecuniary legacy of £50,000 to charity and the residue to F’s sibling.

Is the reduced 36% rate available and what is the tax?

Answer:
Baseline amount for the general component: net estate (£500,000) less the available NRB (£325,000) = £175,000 (ignore RNRB for this test). The charitable legacy is £50,000, which is at least 10% of £175,000 (£17,500), so the reduced 36% rate applies. IHT calculation: Chargeable estate after the charitable gift = £450,000. Apply NRB to the first £325,000 at 0%, leaving £125,000 taxed at 36% = £45,000.

Exam Warning

For SQE1, always apply the NRB to the earliest transfer first, then to later transfers, and finally to the death estate. Do not apply the NRB to the estate before accounting for chargeable lifetime transfers.

Liability to Pay and Payment Dates (at a glance)

Understanding who pays and when is an essential part of applying the NRB and tax rates correctly:

• LCTs (lifetime): IHT is due on the later of six months from the end of the month of the transfer and 30 April after the tax year of the transfer. Primary liability is on the transferor, though trustees commonly bear it from trust funds. If the donor dies within seven years, any additional death tax is due six months from the end of the month of death; the trustees are liable and the burden falls on the trust.
• PETs: No lifetime tax. If the donor dies within seven years, the donee is primarily liable for any IHT on the failed PET; tax is due six months from the end of the month of death. If unpaid after 12 months from the end of the month of death, the personal representatives can become liable.
• Death estate: The personal representatives are liable for IHT on the free estate; tax is due six months from the end of the month of death. Trustees are liable for tax attributable to settled property in which the deceased had a qualifying interest in possession. Where there is a gift with reservation of benefit, the donee is primarily liable for the tax attributable to the property that is treated as remaining in the deceased’s estate.
• Instalments: Certain IHT attributable to land and some shares may be paid by instalments over 10 years, with the first instalment due at the normal due date.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• The nil rate band (NRB) is the threshold up to which no IHT is payable, currently £325,000.
• IHT is cumulative: earlier chargeable transfers within seven years reduce the NRB available for later transfers and for the death estate.
• The NRB is applied in chronological order to chargeable transfers in the seven years before death, then to the death estate.
• PETs are exempt if the donor survives seven years; otherwise, they become chargeable using the NRB and death rates in force at death.
• LCTs are immediately chargeable at 20% above the NRB (25% if the donor bears the tax); if the donor dies within seven years, the tax is recalculated at death rates with credit for lifetime tax paid and taper relief potentially reducing the tax.
• Taper relief reduces only the tax on failed PETs/LCTs made more than three years before death; it does not reduce the value of the gift and has no application where a gift does not give rise to tax.
• The residence nil rate band (RNRB) provides an additional threshold (up to £175,000) where a qualifying residence is closely inherited by direct descendants; it is applied on death before the standard NRB and is tapered for estates above £2 million.
• Unused NRB and unused RNRB can be transferred between spouses/civil partners, with the NRB uplift capped at 100%.
• The 36% reduced death rate applies where at least 10% of the baseline amount is left to charity; the baseline amount ignores the RNRB.
• Liability and payment: donees pay tax on failed PETs; trustees on settled property; personal representatives on the free estate. Additional rules cover due dates and the instalment option.

Key Terms and Concepts

• nil rate band (NRB)
• chargeable transfer
• transferable nil rate band
• potentially exempt transfer (PET)
• lifetime chargeable transfer (LCT)
• taper relief
• residence nil rate band (RNRB)
• cumulative total
• baseline amount
• closely inherited