Learning Outcomes
After reading this article, you will be able to identify who is liable to pay Inheritance Tax (IHT) on a deceased’s estate, explain how the burden of IHT is apportioned among beneficiaries, and apply the statutory and practical rules governing IHT in the context of grants of representation. You will also be able to answer SQE1-style questions on the technical requirements and practical implications of IHT for estate administration.
SQE1 Syllabus
For SQE1, you are required to understand the burden and incidence of Inheritance Tax in the context of estate administration. Focus your revision on:
- the rules determining who is liable to pay IHT on death and on lifetime gifts
- how the burden of IHT is apportioned among beneficiaries and assets
- the statutory rules and the effect of express directions in a will regarding IHT
- the practical implications for personal representatives (PRs) and beneficiaries
- the impact of partially exempt estates and the calculation of IHT in such cases
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.
- Who is primarily liable to pay Inheritance Tax on a deceased’s estate?
- If a will is silent, which part of the estate bears the burden of IHT on a specific legacy to a non-exempt beneficiary?
- What is the effect of an express direction in a will that a legacy is “free of tax”?
- How is IHT apportioned between exempt and non-exempt shares of residue?
Introduction
Inheritance Tax (IHT) is a central consideration in the administration of estates. When a person dies, IHT may be payable on the value of their estate, and the responsibility for paying this tax falls on specific parties. Understanding who is liable, how the burden is allocated, and the statutory rules that apply is essential for effective estate administration and for answering SQE1 questions on grants of representation.
Liability for Inheritance Tax
The liability for IHT on death is set out in statute. The main categories of persons accountable for IHT are:
Key Term: personal representatives (PRs) The executors or administrators responsible for administering the deceased’s estate and paying debts, taxes, and distributing assets.
PRs are primarily liable for IHT on the deceased’s free estate (assets that pass under the will or intestacy). Their liability is limited to the value of assets they receive or would have received but for their own neglect or default.
Key Term: settled property Property held in trust, where the trustees may be liable for IHT attributable to that property.
Trustees are liable for IHT on settled property immediately before death. Beneficiaries who receive property directly (e.g., by survivorship or nomination) may also be liable for IHT on that property if the PRs do not pay.
Burden of Inheritance Tax: Who Ultimately Pays?
The “burden” of IHT refers to which part of the estate (and which beneficiaries) ultimately bears the cost of the tax. This is distinct from “liability,” which concerns who must pay HMRC.
Statutory Default Rules
If a will is silent, the statutory rules apply:
- IHT on property passing to the PRs (the free estate) is treated as a testamentary and administration expense. It is paid primarily from undisposed-of property (if any), then from residue.
- IHT on property not passing to the PRs (e.g., joint property passing by survivorship, nominated property, or settled property) is borne by the recipient of that property.
Key Term: residue The part of the estate remaining after payment of debts, expenses, and specific gifts.
Express Directions in the Will
A testator can alter the statutory rules by including an express direction in the will. For example, a legacy may be given “free of tax,” meaning the tax on that gift is paid from residue. Conversely, a legacy “subject to tax” means the beneficiary bears the tax.
Worked Example 1.1
A testator leaves £100,000 to his nephew and the residue to his spouse. The will is silent on tax. The nephew is not exempt from IHT.
Answer: The IHT on the legacy is paid from residue, reducing the spouse’s share. The nephew receives £100,000 net of tax.
Apportionment of IHT: Partially Exempt Estates
Where an estate is divided between exempt (e.g., spouse or charity) and non-exempt beneficiaries, the burden of IHT is apportioned according to statutory rules:
- Exempt beneficiaries (e.g., spouse, charity) do not bear any part of the IHT attributable to non-exempt shares of residue, even if the will says otherwise.
- Non-exempt beneficiaries’ shares are reduced by the IHT attributable to them.
Key Term: exempt beneficiary A person or entity (such as a spouse, civil partner, or charity) who is not liable to IHT on gifts received from the estate.
Worked Example 1.2
A testator leaves half the residue to his wife and half to his son. The estate is £800,000, with a nil rate band of £325,000. There are no specific gifts.
Answer: The wife’s share is exempt. The son’s share bears all the IHT on the taxable estate above the nil rate band. The wife’s share is not reduced by IHT.
Specific Gifts and Grossing-Up
If a specific legacy to a non-exempt beneficiary is not made to bear its own tax, the IHT on that gift is paid from residue. The amount paid to the beneficiary is “grossed up” to ensure the correct tax is paid.
Key Term: grossing-up The process of increasing a net gift to calculate the total amount (including tax) that must be paid from the estate to satisfy the legacy and the IHT due.
Worked Example 1.3
A will leaves £120,000 to a friend (not exempt) and residue to a spouse. The nil rate band is exhausted. The will is silent on tax.
Answer: The IHT on the £120,000 is paid from residue. The grossed-up amount is calculated so that the friend receives £120,000 net of tax, and the spouse’s share is reduced accordingly.
Practical Implications for Personal Representatives
PRs must ensure that IHT is paid before distributing the estate. They may need to:
- Deduct IHT from legacies if the will directs the beneficiary to bear the tax.
- Pay IHT from residue if the will is silent or directs that a legacy is “free of tax.”
- Recover IHT from recipients of property passing outside the estate (e.g., joint property, settled property) if required.
PRs should not distribute the estate until satisfied that all IHT has been paid, especially where there are lifetime gifts that may become chargeable on death.
Exam Warning
In partially exempt estates, do not assume that IHT is shared equally between exempt and non-exempt beneficiaries. Statutory rules ensure that exempt beneficiaries’ shares are not reduced by IHT on non-exempt shares, regardless of the will’s wording.
Revision Tip
Always check for express directions in the will regarding the burden of IHT. If none, apply the statutory rules. Be prepared to calculate grossed-up amounts for net legacies.
Key Point Checklist
This article has covered the following key knowledge points:
- PRs are primarily liable for IHT on the deceased’s free estate; trustees may be liable for settled property.
- The burden of IHT (who ultimately pays) is determined by statutory rules unless the will provides otherwise.
- In the absence of an express direction, IHT on legacies to non-exempt beneficiaries is paid from residue.
- Exempt beneficiaries’ shares of residue are not reduced by IHT on non-exempt shares.
- Grossing-up is required when a net legacy is given “free of tax.”
- PRs must ensure IHT is paid before distributing the estate and may need to recover tax from beneficiaries of property passing outside the estate.
Key Terms and Concepts
- personal representatives (PRs)
- settled property
- residue
- exempt beneficiary
- grossing-up
