Should you pay tax on money or goods you inherit?
The surprising answer to this question is usually no. This is because inheritance tax (IHT) is usually levied on a person’s estate when they die and can also be payable during a person’s lifetime on certain trusts and gifts. If you are the heir to all or part of the deceased estate, you should not be liable to pay tax on the inheritance. Any IHT due, will normally be paid out of the deceased’s estate before any cash or assets are distributed.
The beneficiaries are liable to income tax on any profit earned after the inheritance, such as dividends from shares and to capital gains tax on any increase in the value of assets that are sold after the date of inheritance.
The main exception to this rule is where you receive a gift during a person’s lifetime. These lifetime transfers are known as Potentially Exempt Transfers (PETs). These gifts or transfers achieve their potential of becoming exempt from IHT, if the taxpayer survives for more than seven years after making the gift. If the taxpayer dies within 3 years of making the gift, then the IHT position is as if the gift was made on death. A tapered relief is available if death occurs between three and seven years after the gift is made.
The effective rates of tax on the excess over the nil rate band are:
- 0 to 3 years before death 40%
- 3 to 4 years before death 32%
- 4 to 5 years before death 24%
- 5 to 6 years before death 16%
- 6 to 7 years before death 8%
The situation is more complicated if the person giving the gift does not fully give up control over the assets concerned. A common example is a person giving their house away but continuing to live in it rent-free. Such gifts are known as ‘gifts with a reservation of benefit’. These gifts can remain subject to IHT even if the taxpayer dies more than 7 years later. There can also be a liability to IHT if an inheritance you receive is put into a trust and the trust can’t or doesn’t pay.