What is the Process for Paying Inheritance Tax on an Estate?

Category: Estate Planning

Dealing with the loss of a loved one is already difficult without the added stress of managing inheritance tax (IHT).

If you have this challenging task ahead, you don’t have to worry, we’ve broken it down into simple, manageable steps. Whether you’re managing an estate or are receiving an inheritance, understanding the process can help you confidently navigate it.

1. Value the Estate

Calculate the total value of the deceased’s assets, including:

  • Property: Obtain a professional valuation.
  • Bank Accounts: Include savings and current accounts.
  • Investments: Shares, bonds.
  • Personal Belongings: Jewelry, cars, artwork.
  • Life Insurance: Policies payable directly to the estate.
  • Pensions: Sometimes included, but often excluded for IHT.

Deduct liabilities such as mortgages, loans, credit card debts, and funeral expenses from this total.

2. Check If Inheritance Tax is Due

Before you dive into paperwork, determine if IHT is due. The standard threshold (or nil-rate band) is £325,000. Anything above this may be taxed at 40%. However, several exemptions can lower this tax bill:

  • Spouse/Civil Partner Exemption: Transfers between spouses or civil partners are usually exempt.
  • Transferrable nil rate band: It’s possible to transfer any unused percentage of the inheritance tax nil rate band from a deceased spouse or civil partner to the surviving spouse or civil partner.
  • Residence Nil-Rate Band: An additional £175,000 allowance if the family home is left to direct descendants. This is also transferrable on first death potentially producing an overall nil rate band of £1,000,000.
  • Charitable Gifts: Donations to charities are IHT-free.
  • Small Gifts Exemption: Gifts up to £250 per person annually are exempt.
  • Annual Exemption: Gifts up to £3,000 each year are not counted towards the estate.
  • Gifts given within seven years before death might still be taxable. These are known as Potentially Exempt Transfers (PETs). Gifts made three to seven years before death are taxed on a sliding scale known as taper relief.

3. Report the Value to HM Revenue and Customs (HMRC)

Depending on the estate’s complexity, complete the following forms:

  • IHT205: For estates where no IHT is due.
  • IHT400: For estates where IHT is due.
  • IHT402: To claim the transfer of unused nil-rate band from a deceased spouse or civil partner.
  • IHT403: To report gifts and other transfers made within seven years of death.
Submit these forms to HMRC within 12 months of the end of the month in which the person died. Attach supporting documents, like valuations and bank statements.

4. Pay the Inheritance Tax

You must pay IHT by the end of the sixth month after the person’s death. Late payments incur interest. Payment methods include:

  • Direct Payment Scheme (DPS): Banks/building societies can release funds directly to HMRC.
  • Bank Transfer: Direct payments to HMRC’s account.
  • Cheque: Send cheques to HMRC.
  • Instalments: Pay over 10 years for certain assets, like property (interest applies). The first instalment is due by the end of the sixth month after the person’s death.

5. Apply for Probate or Letters of Administration

If there’s a will, apply for a Grant of Probate. If there’s no will, apply for Letters of Administration. Use these forms:

  • PA1P: For probate (with a will).
  • PA1A: For administration (without a will).
  • IHT421: Probate summary to confirm IHT has been dealt with.

Submit these forms, IHT documentation, and the death certificate to the Probate Registry.

6. Distribute the Estate

With probate or administration granted, the executor or administrator can:

  • Collect Assets: Gather all assets.
  • Settle Debts: Pay off debts and liabilities.
  • Distribute Bequests: Follow the will or intestacy rules to distribute assets.
  • Maintain Accounts: Keep detailed records of all transactions, payments, and distributions.

Dealing with inheritance tax can be complex but breaking it down into these steps makes the process manageable. Remember to seek professional advice, explore all available reliefs and exemptions, and keep thorough records throughout the process.

For more detailed guidance, check out the official HMRC website. Handling IHT might not be easy, but with the right approach, you can navigate it smoothly and ensure your loved one’s wishes are honoured.

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