How to work out an estate value, including the interaction of reliefs, when legacies in a will are free of tax, and other assets are tax-exempt.
Factors that affect the chargeable part of an estate
Various factors affect the value (the chargeable part) of an estate.
1. The value of what you leave
This will be reduced by the Inheritance Tax threshold £325,000, plus any unused threshold from a late spouse or civil partner.
2. The type of property that you leave
Some types of asset are given relief from Inheritance Tax, such as:
- agricultural property
- heritage assets
3. Who you leave it to
Some beneficiaries are entitled to exemption from inheritance tax, such as:
- your spouse or civil partner
- some charities
- some political parties
4. How you leave it
The terms of your will can affect how much Inheritance Tax is paid and who pays it:
- tax free gifts
- items left in trust
Many factors can affect your decision about how to leave your estate. A solicitor can help you to arrange your affairs.
How to work out the value of a chargeable estate
Step 1. Work out the initial net value of the estate.
Step 2. Deduct any exemptions that apply.
Step 3. Deduct any tax reliefs that apply.
Step 4. Apply the Inheritance Tax threshold.
Ignore property below the Inheritance Tax threshold. Gifts made up to 7 years before death use up the first part of the threshold.
Step 5. Apply the ‘interaction rules’ if necessary.
Even very valuable estates can end up with small Inheritance Tax bills if they include assets that qualify for significant amounts of relief.
In other cases the benefit of a relief on an estate may be lost because of other exemptions being applied. For example, if a farm is left to a charity the benefit of agriculture relief is lost because the charity is exempt from Inheritance Tax.
In such cases the rules of ‘interaction’ are applied to give a fairer Inheritance Tax bill.
An estate is made up of a farm worth £800,000 and other assets valued at £600,000 - an overall initial value of £1.4 million.
The will leaves a gift of £550,000 to the surviving spouse, and the residue (£850,000) to the son.
Without interaction rules being applied, no part of the estate would be chargeable for tax because:
- Agricultural Relief is claimed on the farm
- there is exemption for the spouse
When interaction rules are applied the benefit of the relief available is offset to give a final amount that is chargeable for tax of £364,286.
When to apply the interaction rules
Apply interaction rules if the estate qualifies for Agricultural or Business Relief and the will also contains:
- at least one specific gift of property
- property subject to tax relief that is not specifically given as a gift
The calculations of interaction can be very complex. A professional tax specialist can help.
Step 6. Apply the ‘grossing up’ calculation on tax free gifts.
Inheritance Tax must be paid on any gifts above the threshold that are not eligible for relief. The rate of Inheritance Tax is normally 40% but this is reduced to 36% if more than 10% of your estate is left to charity.
Leaving a gift ‘free of tax’
The value of an estate, tax thresholds and tax rates all change over time and can make the final amount of a gift uncertain. Instead you can opt to leave someone a specific amount ‘tax free’. The tax is then paid by the estate.
In this case HMRC applies a calculation called grossing up when assessing the taxable value of the estate. The exact grossing up calculation will depend on the rate of inheritance tax that will be applied to the estate.
You die with an estate valued at £600,000 with no additional relief from tax applicable. No gifts made in your lifetime need to be considered. In your will you leave:
- £367,000 to your daughter ‘tax free’
- the remaining amount (the residue) to your widow
The first £325,000 of the gift to your daughter will be exempt from tax.
The rest of the gift (£42,000) is chargeable for inheritance tax at the rate of 40%. Applying the grossing up calculation gives a grossed up chargeable value of £70,000.
Adding this back to the tax free threshold (£70,000 + £325000) gives the grossed up value of the gift (£395,000).
Your daughter then receives £367,000 from the estate with no tax to pay.
The estate residue pays the £28000 tax due, leaving £205,000 for your wife.
Using the grossing up calculator tools
If there are gifts left ‘tax free’ and only part of the estate residue is exempt, or when there are gifts made in your lifetime to consider, the calculation for grossing up becomes more complex.
Use the Inheritance Tax grossing up calculators to help with calculations.