Reliefs for Inheritance Tax are outdated and need reviewing and uplifting to reduce complexity for executors. 

Inheritance Tax (IHT) reliefs and allowances have been frozen for so long that they are now part of the permafrost. Some allowances have been unchanged since 1975 - meaning they were set before IHT was even introduced in its current form. While reviewing the main reliefs would be costly, it’s high time some of the smaller allowances were reviewed and updated to reduce burdens on executors.   

Gifting allowances and the annual exempt amount 

When someone dies, it’s not just assets in their estate that are taken into account for IHT, but also any gifts made within the previous seven years. In addition to the main reliefs discussed below, there are range of annual gifting allowances which allow people to make small gifts each year without  IHT consequences.

These reliefs are intended to be administrative simplifications, as it can be challenging for executors to identify all the gifts made after someone has died. But as they have failed to keep pace with inflation they are no longer helpful, and executors have to  rely on claiming more complex reliefs such as gifting out of income, which require executors to consider the deceased’s income and regular pattern of expenditure in the years up to their death. 

The gifting allowances include: 

• The annual exemption – which has been frozen at £3,000 since 1981.
• The small gifts exemption of £250 - which was last increased in 1985. 
• The allowances for gifts on marriage or civil partnership - which have been unchanged since 1975 when they were introduced in as part of Capital Transfer Tax (the tax which preceded IHT).

The annual exemption allows someone to gift up to £3,000 per year without IHT consequences. This is assessed on a cumulative basis so can cover more than one gift. If unused in one year, it can be carried forward to the next.

The small gifts allowance applies to a single gift to an individual in a year and is a strict limit – so a gift of £251 gets no relief under this heading. 

The allowances for gifts on marriage or civil partnership depend on the donor’s relationship to the person getting married. A parent can gift £5,000 without IHT consequences on the occasion of their son’s or daughter’s marriage/civil partnership but the limit is reduced to £2,500 for a grandparent and £1,000 for any other person. 

Based on the Bank of England’s inflation calculator, the annual gift allowance would now be in the region of £11,800, with the small gifts allowance at just over £795. The parental gift allowance on marriage would be a whopping £39,800 if uplifted from 1975 values. 

A detailed review of IHT was carried out by the Office of Tax Simplification in 2019, who suggested that the small gifts allowance should be increased to reduce the administration burden for executors, while the annual exemption and the allowances on marriage/civil partnership should be replaced with a single, increased gift allowance. 

Nil rate band (the amount of an estate that can be passed on tax-free)

After the exemption for transfers between spouses or civil partners, the nil rate band (NRB) is the next major IHT relief. It sets the threshold above which IHT is charged. For an estate to be subject to IHT, the value of assets in the estate, plus any gifts in the previous seven years, need to be in excess of £325,000. 

The NRB was last updated 17 years ago in April 2009. The Chancellor intends to extend the freeze to April 2031, by which time the relief will have be unchanged for 22 years. 

Increasing the nil rate band would be costly for the Government, as it would allow more estates to escape IHT. If it had increased in line with inflation, it would now be in the region of £530,000. 

Politically, it is unlikely the Government would want to increase the NRB to this level. But it would be possible to drastically simplify the landscape by merging the NRB with another relief, the residential nil rate band (RNRB). The RNRB allows individuals to leave up to another £175,000 tax-free if their estate includes a property they have lived in (or the sale proceeds of such a property) to their descendants. 

The creation of the RNRB has introduced substantial complexity into the administration of IHT. It also creates distortions, as two estates of equal value can have different IHT liabilities depending on the value of residential property held by the deceased and whether or not they have children who are inheriting that property. 

The Association of Taxation Technicians have previously suggested merging the two reliefs. This would help to bring the NRB up with inflation while removing the complexity of the RNRB.