On the 11th July 2023, the interest rate for Inheritance Tax was increased for the second time this year to 7.5%. With large sums potentially at stake, it is now more important than ever to pay any Inheritance Tax due on an estate within the specified sixth month post-death window. This penalty and strict time frame adds to the already complex probate process which many executors have to deal with during a very difficult time in their lives.
In our latest article, we consider how to mitigate interest on Inheritance Tax and any exemptions that may be available.
What is Inheritance Tax?
Inheritance tax (IHT) is a form of tax which may be payable when somebody dies. Liability for inheritance tax is calculated on the assets that the deceased owned when they died (i.e., property, cash, and shareholdings). The responsibility to calculate the potential inheritance tax liability falls upon the deceased’s executor or personal representative.
Interest Rates for Inheritance Tax
The executor has to the end of the sixth month after the individual has died to pay the inheritance tax due. After this date, interest starts to accrue.
On 31st May 2023, the interest rate for inheritance tax went up to 7%. However, from 11th July 2023, the interest rate increased again to 7.5% (more than double that of the interest rate on 4th July 2022). Accordingly, overdue IHT payments will now be subject to the new 7.5% rate of interest.
In contrast, the interest that HM Revenue & Customs (HMRC) will apply to any overpayment made by the executors on account is currently 3.5%. This demonstrates the importance of making a payment on account within this time frame, where possible. Especially as overpaid tax, plus interest, can be reclaimed i.e., when full details of the deceased’s assets and liabilities have been finalised.
Within our Estate Administration team at Hugh James, we come across estates in which there may be limited funds available to settle the inheritance tax. For example, when the deceased’s property is the primary asset held and needs to be sold to release funds. However, in these situations, we consider how best to address the inheritance tax position and mitigate any interest which could accrue in the interim.
Mitigating interest on Inheritance Tax
It is important to consider how best to make a payment on account to HMRC. The executor could consider the following options:
- make a payment from the available cash assets i.e., bank accounts already closed
- request payment from a third party, such as a share portfolio or life policy, directly to HMRC
- consider whether a beneficiary may want to use their own funds to pay HMRC (by introducing funds into the estate) to avoid paying interest
- consider payment by instalments, which could reduce the amount of interest payable overall
- consider whether an inheritance tax loan could be secured (either by the executors or by a beneficiary)
When reviewing the inheritance tax position, it is necessary for the executor to complete a set of estate accounts, as well as an inheritance tax return. The type of inheritance tax return will depend on the value of the estate, and any exemptions available. Exemptions can reduce or remove the inheritance tax liability altogether and must be considered on a case-by-case basis.
The primary exemptions available include:
- The nil rate band – everyone has an allowance of £325,000 free from inheritance tax, applicable against their assets held at the date of their death.
- Transferrable nil rate band – any available nil rate band not used on the death of the first spouse when the deceased’s estate passes to their surviving spouse.
- Residence nil rate band – available when the estate passes to lineal descendants and the assets include a property. This is currently £175,000.
- Transferrable residence nil rate band – Also £175,000 and transferrable when unused on the first spouse’s death.
- Spousal exemption – no inheritance tax payable on an estate up to £3 million when the estate fully passes to the spouse.
- Charity exemption – no inheritance payable on an estate up to £3 million when the estate fully passes to a UK registered charity.