Taxation in wills and administration - Inheritance Tax

Learning Outcomes

This article covers inheritance tax in wills and administration, including:

• The occasions when IHT is chargeable in lifetime and on death, including relevant property trust events
• The distinction between potentially exempt transfers (PETs) and lifetime chargeable transfers (LCTs), and the seven‑year cumulation and taper relief rules
• Core exemptions and reliefs: spouse/civil partner and charity exemptions; annual, small and marriage gifts; normal expenditure out of income; BPR and APR
• The strict calculation sequence for lifetime and death transfers and the correct application order of exemptions, reliefs, cumulation, bands and rates
• Applying the nil rate band (NRB), transferable NRB, and the residence nil rate band (RNRB), with eligibility, tapering above £2 million, and downsizing provisions
• The 10% charity test, baseline amount and estate components, when the 36% reduced rate applies, and use of the estate rate for apportionment
• Identifying anti‑avoidance issues: gifts with reservation of benefit and pre‑owned assets, and avoiding double‑charge pitfalls
• Duties of personal representatives: valuing assets and debts, claiming reliefs, completing HMRC forms, and funding and paying IHT (including instalments and the Direct Payment Scheme)
• Liability and burden of IHT: primary liability of donees of failed PETs and trustees on LCTs, PRs’ secondary liability, and apportionment to specific gifts
• Practical pointers on timelines, RNRB conditions, deadlines, and common calculation errors

SQE2 Syllabus

For SQE2, you are required to understand the core principles of inheritance tax as it applies to estate administration, with a focus on the following syllabus points:

• the occasions when inheritance tax is chargeable (lifetime and death transfers)
• the difference between potentially exempt and immediately chargeable transfers
• the main exemptions and reliefs available from IHT, including spouse/civil partner and charity exemptions
• the calculation and application of nil rate band (NRB), transferable NRB, and residence nil rate band (RNRB), including tapering for large estates
• the payment and timing of IHT, including PR obligations and instalment options
• the practical issues for personal representatives, including form completion, funding tax before the grant, and priority of payments
• the liability and burden of IHT on death, including apportionment by estate rate
• the anti‑avoidance provisions relevant to wills practice (gifts with reservation of benefit and pre‑owned assets)
• the basic trust charging events that impact estates (relevant property regime at entry, anniversaries, exits)

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. For which three types of occasions may inheritance tax become chargeable on a person’s estate or relevant property?
2. Briefly explain the difference between a potentially exempt transfer (PET) and a lifetime chargeable transfer (LCT).
3. A testator dies leaving all his estate to his spouse, but he made a substantial gift to his son two years before death. What is the tax position, and what action must the PRs take?
4. Identify two key exemptions and one main relief that reduce IHT on death estates.

Introduction

Inheritance tax (IHT) is an important consideration in the administration of estates. IHT may arise during a person’s lifetime or on their death. Personal representatives must understand the rules to ensure correct calculation and payment. This article focuses on the main chargeable occasions, key exemptions and reliefs, calculation principles, and the role of PRs in handling IHT.

IHT is principally governed by the Inheritance Tax Act 1984 (IHTA 1984). The tax is charged on the “value transferred” by a chargeable transfer, which in practice means the reduction (loss) in the transferor’s estate caused by the transaction. Rates, bands, and qualifying reliefs must be applied in a strict, consistent order to reach a correct figure.

When does IHT arise?

IHT may be payable on three types of occasions:

• On the death of an individual (the death estate)
• On certain lifetime gifts (potentially exempt transfers and chargeable transfers)
• On transfers into relevant property trusts and certain trust events

Key Term: chargeable transfer
A gift or transfer of value that is subject to IHT unless exempt.

Key Term: potentially exempt transfer (PET)
A lifetime transfer from an individual to another individual or into certain qualifying trusts (e.g., disabled person’s trusts) that is exempt if the transferor survives seven years; otherwise it becomes chargeable at death rates.

Key Term: lifetime chargeable transfer (LCT)
A lifetime transfer to a company or most trusts that is immediately chargeable to IHT when made; if the donor dies within seven years, it may suffer additional tax at death rates.

Property subject to IHT

IHT is charged on a person’s estate at death, which includes all property the deceased owned beneficially immediately before death (less allowable liabilities). The ‘death estate’ also includes certain gifts made within seven years of death if they are not fully exempt.

Key Term: death estate
All assets beneficially owned by the deceased at death, after deducting qualifying liabilities.

Beyond assets passing under a will or intestacy, the tax estate also includes:

• The deceased’s beneficial share of joint tenancy property (even though it passes by survivorship and does not vest in PRs)
• Trust property where the deceased had a qualifying interest in possession (the trust fund is aggregated with the death estate)
• Gifts with reservation of benefit (property given away but enjoyed by the donor continues to be treated as part of the estate at death)
• Donatio mortis causa gifts (made in contemplation of death and effective on death)
• Excluded property is outside scope (most notably non‑UK assets of a non‑UK‑domiciled person), but domicile must be assessed carefully

Key Term: gift with reservation of benefit (GWR)
A lifetime gift where the donor retains a benefit; the gifted asset is treated as part of the donor’s estate at death for IHT purposes unless full consideration is paid for the retained benefit.

Main exemptions and reliefs

Certain transfers are exempt from IHT. The most important exemptions for exam purposes are:

Key Term: spouse/civil partner exemption
Transfers between spouses or civil partners are exempt from IHT, whether made during lifetime or on death. Where the recipient spouse/civil partner is non‑UK‑domiciled, a statutory cap may apply unless an election to be treated as UK‑domiciled is made.

Key Term: charity exemption
Transfers to UK‑registered charities are exempt from IHT (and the estate may qualify for a reduced tax rate if sufficient passes to charity).

Annual exemption (currently £3,000 per tax year, with one year’s unused allowance carry‑forward) and small gifts exemption (£250 per recipient per tax year) apply to certain lifetime gifts only. Gifts on marriage/civil partnership are exempt within statutory limits. Substantial regular gifts made as part of normal expenditure out of income can also be exempt.

Key Term: normal expenditure out of income
An exemption for lifetime gifts that form part of the donor’s normal (habitual) spending, are made out of surplus income (not capital), and leave the donor with sufficient income to maintain their usual standard of living.

Other key reliefs include:

Key Term: business property relief (BPR)
A relief reducing IHT on certain qualifying business assets (typically 100% for interests in trading businesses or shares in unquoted trading companies; 50% for some controlling interests in quoted companies and certain assets used in a business).

Key Term: agricultural property relief (APR)
A relief reducing IHT on qualifying agricultural property, subject to occupation and ownership conditions.

Post‑mortem reliefs may adjust the value for IHT where quoted shares or land are sold by PRs at a loss within specified time limits. Quick succession relief can reduce IHT where a recipient dies within five years of receiving chargeable property.

Key Term: quick succession relief (QSR)
A relief reducing IHT on a death estate where the deceased received chargeable property within the preceding five years; the relief depends on time elapsed and tax paid on the earlier transfer.

The nil rate band (NRB) and residence nil rate band (RNRB)

Every individual has a nil rate band (£325,000 at the time of writing), so transfers up to this value are charged at 0%. Transfers over this threshold are charged at 40% (or 36% if the estate qualifies for the reduced rate by giving at least 10% of a component’s baseline amount to charity).

If the deceased leaves a residence (or the sale proceeds) to a direct descendant, their estate may benefit from an additional residence nil rate band (RNRB). RNRB is tapered for estates over £2 million and has complex conditions, including “closely inherited” and downsizing provisions. Both NRB and RNRB can be transferred from a predeceased spouse/civil partner if unused.

Key Term: nil rate band (NRB)
The value of property that can be transferred without paying IHT (charged at 0%), currently £325,000; a deceased may claim the unused percentage of a predeceased spouse/civil partner’s NRB.

Key Term: residence nil rate band (RNRB)
An extra threshold for IHT where a qualifying residential interest (or its traceable proceeds) is left to direct descendants; subject to tapering for larger estates and complex eligibility rules, and transferable if unused.

The cumulative total and the seven-year rule

When calculating IHT on death, PETs and LCTs made within the seven years before death are aggregated to determine whether the nil rate band has been used up. NRB is allocated first to lifetime transfers in that period, and only the remaining NRB is available to the death estate. Each transfer has its own cumulation period, which can mean a transfer still affects cumulation up to 14 years later (e.g., an LCT made more than seven years before death can still reduce the NRB available to a PET made within seven years of death).

Where death occurs more than three but less than seven years after a lifetime gift, taper relief reduces the tax payable on that lifetime gift (not its value).

Key Term: taper relief
A reduction in the IHT payable on certain lifetime transfers if the transferor dies more than three years after the gift; it reduces tax, not the transfer value.

How is IHT calculated?

For the exam, you need to be able to:

• Identify when lifetime gifts or transfers are taxed as PETs or LCTs and understand the effect if the transferor dies within 7 years
• Apply the NRB and any available RNRB, and understand the effect of pre-death gifts on the available threshold
• Understand which exemptions or reliefs can be claimed, and in what order
• Recognise when the 36% reduced rate applies due to charitable legacies and how to compute the baseline amount
• Use estate rate to apportion tax burdens across assets where relevant

The calculation sequence must be followed strictly for each transfer (lifetime and death):

1. Establish the value transferred (loss to the estate)
2. Deduct applicable exemptions
3. Deduct applicable reliefs
4. Cumulate earlier chargeable transfers in the relevant seven-year period
5. Identify the remaining NRB (and RNRB on death where conditions are met)
6. Apply tax at the correct rate (20% for LCTs, 40% on death, or 36% if the charity reduced rate applies)
7. Apply taper relief to tax on lifetime transfers where appropriate

Worked Example 1.1

A client gave £200,000 to her daughter five years before death and £100,000 to her son three years before death. On death, her estate is worth £500,000, all left to her partner (who is not married to her). She has made no other gifts. What IHT is payable?

Answer:
Both gifts are PETs (to individuals). Because the client died within seven years, the PETs become chargeable but are assessed in their own cumulation periods first. The £200,000 PET (five years before death) is within the NRB, so no tax is payable on it. The later £100,000 PET is cumulated with the earlier £200,000 PET (total £300,000), also within the NRB, so no tax is payable on the PETs themselves. However, lifetime transfers use the NRB first. Only £25,000 of NRB remains for the death estate. The estate is £500,000 to a non‑exempt partner, so £475,000 is taxable at 40% = £190,000. (Ignoring annual exemptions for simplicity; these would slightly reduce the cumulative total.)

Main exemptions and reliefs (expanded)

• The spouse/civil partner exemption applies to both lifetime and death transfers. Transfers to cohabitees (not married or civil partners) are not exempt.
• The charity exemption applies to death and lifetime gifts to registered charities. If at least 10% of a component’s baseline amount passes to charity, a reduced 36% rate applies to that component (PRs can elect to merge components so the reduced rate applies across them).
• The annual exemption (up to £3,000 per year, with one year’s carry‑forward) can be set against lifetime gifts; the small gifts exemption (£250 per recipient) cannot be combined with another exemption for the same recipient in the same tax year.
• Gifts on marriage/civil partnership: specific exempt amounts depending on the donor’s relationship.
• Normal expenditure out of income can exempt substantial regular gifts if the statutory tests are met.
• BPR and APR can remove the value of business or agricultural assets from tax, but only if conditions are met (e.g., trading nature, ownership periods, and control tests).
• Post‑mortem reliefs (quoted shares sold at a loss within 12 months; land and buildings sold at a loss within 3 years) can generate IHT repayments.
• Quick succession relief may reduce IHT where death follows receipt of chargeable property within five years.

Worked Example 1.2

A widow dies leaving £1m to her three children in equal shares, with a house worth £500,000. She made no PETs or LCTs in the seven years before her death and was predeceased by her husband ten years earlier with all his assets left to her. What is the maximum NRB available, and what will be the taxable estate?

Answer:
The widow can claim her own NRB (£325,000) plus her late husband's unused NRB (100% transferable), giving a total NRB of £650,000. If her will leaves the home (or a qualifying residential interest) to her direct descendants, she also claims the RNRB (currently up to £175,000), for a total of £825,000 at 0%. Thus, £175,000 is taxable at 40% = £70,000. No tapering of RNRB applies as the estate is below £2 million.

Charity reduced rate: baseline amount and components

An estate is divided into components (general, survivorship, settled property) for the 10% test. The baseline amount for a component is calculated after deducting debts, exemptions (other than charity), and reliefs, and after proportionally allocating the NRB. If the charitable legacy equals or exceeds 10% of the baseline amount, tax on that component is at 36%. PRs may elect to merge components to achieve the reduced rate where beneficial.

Key Term: estate rate
The average rate of IHT across the chargeable estate; used to apportion tax to specific assets, to calculate instalments on land/business property, and to determine who bears tax where gifts are “subject to tax”.

Worked Example 1.3

The executor of a will discovers after distribution that the deceased gave £90,000 to his brother three years before death but failed to declare it. The deceased's NRB was already fully used by other gifts. Who is now liable for the extra IHT?

Answer:
The recipient of the gift (the brother) is primarily liable for the IHT on the failed PET. If the tax remains unpaid 12 months after the end of the month of death, the PRs can become liable for the unpaid tax, limited to assets they have received or distributed. PRs should warn recipients early where recovery from them may be required.

Worked Example 1.4

Graham’s estate comprises a house (£210,000) and residue (£190,000). He made no lifetime transfers. His will leaves the house to Henry “subject to tax” and residue to Ian. What tax does each bear?

Answer:
IHT on the estate: £325,000 @ 0% = nil; £75,000 @ 40% = £30,000. The estate rate is £30,000/£400,000 = 7.5%. Henry bears tax on the house of £210,000 × 7.5% = £15,750 (as the house is “subject to tax”). Ian bears £14,250 on residue (£190,000 × 7.5%).

Worked Example 1.5

Harriet settles £340,000 into a discretionary trust (an LCT) when she has no NRB remaining. Trustees pay the tax. What is the immediate IHT and what if she dies six years later?

Answer:
Immediate lifetime tax at 20% on £340,000 = £68,000 (paid by trustees). If Harriet dies more than six but less than seven years later, the transfer is recalculated at 40% = £136,000, then taper relief of 80% applies (only 20% payable): £27,200. Credit is given for the £68,000 already paid; no refund is available where the recalculated tax is lower than the lifetime tax.

Relevant property trusts: why they matter in estates

Trust events (entry by lifetime transfer, ten‑year anniversaries, and exits) are chargeable occasions. While detailed trustee calculations are beyond the scope of typical wills administration tasks, PRs must identify whether the deceased had an interest in possession (aggregating trust property with the death estate) or whether settled property is part of the relevant property regime (tax paid by trustees on anniversaries and exits). PRs also need to know where tax liability sits to ensure the estate pays only the IHT attributable to non‑settled property.

Duties of personal representatives

Personal representatives (PRs) are responsible for calculating and paying any IHT due on the death estate. They must:

• Ascertain the value of all the deceased's assets and debts (including non‑probate assets that form part of the IHT estate, e.g., joint tenancy shares)
• Identify any PETs or LCTs the deceased made within seven years before death (usually by reviewing bank statements, engaging with family, and requesting information)
• Claim all allowable exemptions and reliefs (including transferable NRB and RNRB, and any post‑mortem reliefs)
• Calculate and pay IHT due before applying for a grant of representation
• Apportion the burden of IHT correctly (by will direction or statutory rules), and use the estate rate to allocate tax to specific items where appropriate
• Keep full records (inventory and account) and consider obtaining an HMRC certificate of discharge when appropriate

Key Term: personal representative (PR)
A person appointed to administer the estate of a deceased person. Includes executors (if appointed by will) or administrators (if appointed by the court).

Funding the tax before the grant can be a practical challenge. Common solutions include:

• Using the Direct Payment Scheme: banks/building societies remit funds directly to HMRC on IHT423
• Loans from beneficiaries (especially where they have already received non‑probate benefits, e.g., life policy proceeds)
• Bank borrowing against an undertaking to repay from first realisations
• In limited cases, paying from assets realisable without a grant (small balances) or asking for a grant on credit in exceptional circumstances
• Life assurance proceeds payable to the estate may be remitted directly to HMRC

Key Term: grant of representation
The document giving PRs legal authority to deal with the estate. It will not issue until HMRC confirms IHT has been paid (unless IHT is not immediately due or the estate is excepted).

PRs must also understand the incidence of liabilities:

• Secured debts normally attach to the specific property (unless the will states that the mortgage is to be paid from residue)
• Unsecured debts, testamentary and administration expenses, and IHT are paid following statutory rules unless the will directs otherwise
• Where gifts are expressed “subject to tax”, the recipient bears tax attributable to that asset

Payment and timing of IHT

Inheritance tax on the death estate is normally payable six months after the end of the month of death. Delayed payment attracts interest. For certain assets (e.g., land, some business interests, and shares in unquoted companies), IHT can be paid in instalments over 10 years. The PRs must pay the tax (or secure instalment arrangements) before the grant is issued.

IHT on chargeable lifetime transfers is due by the later of six months after the end of the month of transfer and 30 April after the relevant tax year. On death, any additional tax due on LCTs is payable six months after the end of the month of death; the trustees are primarily liable, with PRs potentially liable if unpaid after 12 months.

For PETs that become chargeable, the recipient is primarily liable for tax (due six months after the end of the month of death). If unpaid after 12 months, PRs may become liable (limited to estate assets under their control).

Gifts with reservation of benefit are treated as part of the death estate; the donee is usually primarily liable for the IHT on the reserved property, and PRs can become liable if unpaid after 12 months.

Key Term: excepted estate
An estate that meets statutory conditions so that a full IHT account is not required; recent regulations have simplified criteria and removed the need for form IHT205 in most cases, but PRs must check current HMRC guidance at the time of application.

PRs should also be familiar with core forms and processes for non‑excepted estates:

• IHT400 (main account) and relevant schedules (e.g., IHT403 for lifetime gifts, IHT402 for transferable NRB, IHT436 for RNRB)
• IHT421 (HMRC probate summary) sent to the Probate Registry once HMRC is satisfied
• IHT422 (reference number) and IHT423 (Direct Payment Scheme authority)
• Corrective accounts to update valuations and tax if information changes

Exam Warning

• Apply the calculation order strictly: exemptions first, then reliefs, then cumulation, then bands and rates, then taper relief (only to tax on lifetime transfers).
• On death, NRB is allocated first to lifetime transfers in the prior seven years; only the remainder is available to the death estate.
• Do not confuse exemption (removes the transfer entirely) with relief (reduces the taxable value or rate).
• Remember RNRB conditions: qualifying residential interest, closely inherited by direct descendants, tapering above £2 million, and downsizing rules.
• Check whether the charity reduced rate could apply and calculate the baseline amount correctly.
• Identify gifts with reservation and warn of double charge traps; consider POAT where relevant in lifetime planning.
• Always confirm where liability and burden fall: recipients of failed PETs, trustees on LCTs post‑death, and PRs on non‑settled estate.

Revision Tip

Use timelines to map lifetime transfers and death, noting the seven-year windows for each transfer. Highlight exemptions and reliefs on the timeline, then apply cumulation and bands. For estates including land or business assets, consider instalments and apportionment by the estate rate. Keep a checklist of forms and payment routes (Direct Payment Scheme, loans, instalments) to ensure pragmatic advice to PRs.

Summary

• IHT can arise in lifetime or on death, or on relevant trust events.
• The NRB (and RNRB if available) is key for calculating tax thresholds; NRB is used first by lifetime transfers within seven years of death.
• Spouse/civil partner and charity exemptions remove gifts to such recipients from charge; other exemptions (annual, small, marriage, normal expenditure out of income) apply to lifetime gifts.
• PETs become chargeable if the transferor dies within seven years; LCTs are immediately chargeable (and may be recalculated on death).
• Taper relief reduces tax on lifetime transfers where death occurs more than three years after the transfer; it does not reduce the transfer value.
• PRs must fund and pay IHT before obtaining a grant, except in limited cases (e.g., instalments or excepted estates), and should use practical funding routes where needed.
• Key reliefs (BPR, APR), the charity reduced rate, quick succession relief, and post‑mortem loss reliefs can materially reduce tax if conditions are met.
• Liability for unpaid IHT can fall on recipients of failed PETs, trustees of LCTs, donees of reserved gifts, and ultimately PRs if tax remains unpaid after 12 months.

Key Point Checklist

This article has covered the following key knowledge points:

• The three main occasions when IHT may apply: on death, on certain lifetime gifts, and on trust events
• The differences between potentially exempt transfers and immediately chargeable transfers
• Calculation and application of the nil rate band and residence nil rate band, including transferable allowances and RNRB tapering
• Key exemptions: spouse/civil partner, charity, annual exemption, small gifts, marriage gifts, normal expenditure out of income
• Main reliefs: business property relief, agricultural property relief, taper relief, quick succession relief, post‑mortem loss reliefs
• Charity reduced rate mechanics and baseline amount calculation
• The duties of PRs in valuation, tax calculation, timing, funding, and payment (including forms and Direct Payment Scheme)
• Liability and burden: apportionment using the estate rate; recipients/trustees primarily liable for PETs/LCTs with PRs’ secondary liability in default
• Anti‑avoidance: gifts with reservation of benefit and pre‑owned assets considerations

Key Terms and Concepts

• chargeable transfer
• potentially exempt transfer (PET)
• lifetime chargeable transfer (LCT)
• death estate
• spouse/civil partner exemption
• charity exemption
• normal expenditure out of income
• business property relief (BPR)
• agricultural property relief (APR)
• nil rate band (NRB)
• residence nil rate band (RNRB)
• taper relief
• quick succession relief (QSR)
• estate rate
• personal representative (PR)
• grant of representation
• gift with reservation of benefit (GWR)
• excepted estate