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If your estate is worth over £325,000 when you die Inheritance Tax may be due. From 6 April 2012, if you leave 10 per cent of your estate to charity the tax due may be paid at a reduced rate of 36 per cent instead of 40 per cent. This article explains the main rules.
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Any gifts you make to a 'qualifying' charity - during your lifetime or in your will - will be exempt from Inheritance Tax.
In order to qualify for the reduced rate you must leave at least 10 per cent of the net value of your estate to a qualifying charity.
The net value of your estate is the sum of all the assets after deducting any debts, liabilities, reliefs, exemptions and the nil-rate band.
A qualifying charity is an organisation that’s recognised as a charity for tax purposes by HM Revenue & Customs (HMRC). For Inheritance Tax purposes a Community Amateur Sports Club (CASC) is also treated as a qualifying charity. You can check this by asking the charity to confirm that it has an HMRC charity reference number. Find out more by following the link below.
There are different ways that you can own assets such as money, land or buildings and the way that you own the assets and with who affects the way they're treated when deciding whether the reduced rate of tax can apply.
To see how much you need to leave to charity to qualify or whether your estate can pay a reduced rate of Inheritance Tax because of a charitable donation left in a will, you have to work out the value of each of the separate parts of an estate. These are known as 'components'. It's possible that one part of your estate may pay Inheritance Tax at 36 per cent and another pay tax at the full rate of 40 per cent.
To work out whether the reduced rate applies, your estate and your assets are broken down into three components as follows:
Find out more about components in the section 'Assets that do and don’t qualify to pay reduced rate Inheritance Tax' below.
It's also possible to merge one or more components to gain the maximum benefit from the reduced rate. Follow the first link below to worked examples. Example 3 in this guidance shows how this works.
Assets that are classed as 'gifts with reservation' may also qualify to pay tax at the reduced rate, but only if they are merged with one or more of the three components of the estate.
If you haven’t left assets to a qualifying charity or if the donation in your will doesn't pass the 10 per cent test when you die, the beneficiaries of your estate can arrange an 'Instrument of Variation' to make or increase a donation to charity. Doing so may mean that your estate can then qualify to pay Inheritance Tax at 36 per cent.
Find out more about varying a will by following the link below.
Any assets that you own jointly and equally with one or more people where your share passes automatically by' survivorship' to the other joint owners when you die will fall into the ‘survivorship’ component. Survivorship rules can be different in other countries.
If you have a joint bank account with someone else but you've provided all of the money in it, the full amount - rather than half the amount - will be included in the valuation of your estate. However it will still be included as part of the survivorship component because the money passes automatically to the other owner(s).
Assets passing by survivorship will only qualify for tax to be paid at 36 per cent if they're merged with another component or if they're included in an Instrument of Variation.
If you own a number of items of joint property with different joint owners all of the jointly owned assets are added together to make up the ‘survivorship’ component. Only if the donation is more than 10 per cent of this total will the reduced rate apply, so action by a single owner to merge components may not be enough to qualify.
If you're the beneficiary of a trust and the trust assets form part of your estate when you die for Inheritance Tax purposes, then any such assets will fall into the ‘settled property’ component.
If you're the beneficiary of more than one trust and Inheritance Tax is due on them, the donation to charity has to be more than 10 per cent of the total value of all of them in this component to qualify for a reduction in tax.
It's not possible to vary the destination of trust assets by an Instrument of Variation.
In the majority of cases any assets that you own outright or joint assets owned as tenants in common with someone else are the assets that fall into this component - the general component.
If you make any gifts before you die that are classed as 'gifts with reservation' these won't be free from Inheritance Tax. Any assets that are classed as being a gift with reservation of benefit won't qualify for tax to be paid at 36 per cent. Assets in this component will only qualify for the reduced rate if they're merged with another component that qualifies for the reduced rate of Inheritance Tax.
The steps below explain how you work out the calculation. The calculation is complicated and the easiest way to work out whether an estate will qualify to pay Inheritance Tax at 36 per cent is to use the reduced rate calculator. You can do this by following the link at the end of this section.
Step 1 - work out which assets fall into each component - remember not all estates have all three components.
Step 2 - add up the assets then deduct any debts, liabilities, reliefs and exemptions that apply to each component.
Step 3 - apportion the Inheritance Tax nil rate band - including any transferable unused nil rate band from a spouse or civil partner - between the number of components being used and any assets classed as ‘gifts with reservation’.
Step 4 - deduct the apportioned value of the nil rate band from each component.
Step 5 - add back in the value of the donation to charity - this result is the 'baseline amount' for each component.
Step 6 - divide the baseline amount by 10.
Step 7 - work out whether the charitable donation is more than the result of the sum at step 6.
To see worked examples of calculating charitable donations that show how estates can pay Inheritance Tax at 36 per cent follow the link below.
You can claim the reduced rate of Inheritance tax by completing form IHT430 Reduced rate of Inheritance Tax with form IHT400 - Inheritance Tax Account.
To avoid the need to continually revise the amount of charitable donations written into wills, HMRC's technical guidance includes an example of the wording of a clause that can be included on a will to ensure that it will always meet the ten per cent test.
Occasionally a personal representative may agree with the beneficiaries that they will opt out of applying to pay Inheritance Tax at a reduced rate and elect to pay tax at 40 per cent. This is to make dealing with the estate simpler. For example if you leave your house to charity when you die, it doesn't need to be valued because it's exempt from tax and won't be included as part of your estate for Inheritance Tax. However to work out whether the estate would qualify to pay the Inheritance Tax reduced rate then the house would need to be professionally valued and the cost of doing so might outweigh the benefits. If you want to opt out of paying the reduced Inheritance Tax rate you need to complete form IHT 430 Reduced rate of Inheritance Tax with form IHT400 - Inheritance Tax Account.