Not everyone pays Inheritance Tax on death. It only applies if the taxable value of your estate (including your share of any jointly owned assets and assets held in some types of trusts) when you die is above £300,000 (2007-2008 tax year).  It is only payable on the excess above this nil rate band.

There are also a number of exemptions which allow you to pass on amounts (during your lifetime or in your will) without any Inheritance Tax being due, for example:

If your estate passes to your husband, wife or civil partner and you are both domiciled in the UK there is no Inheritance Tax to pay even if it's above the £300,000 nil rate band

most gifts made more than seven years before your death are exempt (but see the next section on trusts and companies)

certain other gifts, such as wedding gifts and gifts in anticipation of a civil partnership up to £5,000 (depending on the relationship between the giver and the recipient), gifts to charity, and £3,000 given away each year are also exempt

Transfers into trusts and companies

Transfers of assets into most trusts and companies are subject to an immediate Inheritance Tax charge if they exceed the Inheritance Tax nil rate band (taking into account the previous seven years' chargeable gifts and transfers). Read our related article Inheritance Tax on transfers into trusts and companies. The rest of the current article deals with Inheritance Tax on an individual's estate on death.

Transfers of money or property into most trusts and companies are subject to an immediate Inheritance Tax charge on values that exceed the Inheritance Tax 'threshold'. Tax is also payable ten-yearly on the value of trust assets above the threshold. Certain trusts are exempt from these rules.

Inheritance Tax on transfers into trusts

From 22 March 2006 transfers above the Inheritance Tax threshold into most types of existing or newly created trust are immediately chargeable to 20 per cent Inheritance Tax on the excess amount. The tax is payable by the trustee (the person administering the trust) at the time of the transfer into the trust.

What counts as 'above the Inheritance Tax threshold'?

The current Inheritance Tax threshold is £300,000 (tax year 2007-2008). In order to work out whether the Inheritance Tax threshold has been exceeded on a transfer you need to take into account all 'chargeable' (non-exempt, including potentially exempt) gifts and transfers made in the previous seven years. If a transfer takes you over the threshold, Inheritance Tax is payable at 20 per cent on the excess.

Trusts not affected by the new Inheritance Tax rules

Trusts not affected by the new rules (and so where no Inheritance Tax is payable on any transfers) are:

·           lifetime transfers into a trust for a disabled person

·           trusts created on death for a disabled person

·           trusts created on death for a minor child of the deceased in which the child will become fully entitled to the assets at age 18

·           trusts set up under a will for someone who is not a disabled person or minor child of the deceased who becomes entitled to their benefit on the death of the person who wrote the will

Options for existing trusts

Existing accumulation and maintenance trusts have until 6 April 2008 to change (where appropriate) the trust's rules to enable them to fall outside the new rules.

Interest in possession (IPP) trusts that existed before 22 March 2006, or which replace a pre-March 2006 IPP up to 6 April 2008, will continue to benefit from the old rules until they come to an end.

All other newly created IPP trusts will come under the new rules.

Inheritance Tax on transfers into companies

Transfers into a company that are above the Inheritance Tax threshold (taking into account all chargeable gifts and transfers made in the previous seven years) are also immediately chargeable to 20 per cent Inheritance Tax on the excess amount. The person making the transfer pays the Inheritance Tax at the time the transfer is made.

If you die within seven years of making a transfer

If you die within seven years of making a transfer into a company or trust on which you have already paid 20 per cent Inheritance Tax the tax due is recalculated using the Inheritance Tax rate threshold applicable on death (currently 40 per cent). Tax will be payable by your estate to HM Revenue & Customs (HMRC) on the difference.

If you made a transfer on which no Inheritance Tax was due at the time, its value is added to your estate when working out any Inheritance Tax that might be due.

Ten-year Inheritance Tax charge on trusts

Trusts that count as 'relevant property trusts' must also pay:

·           a 'periodic' tax charge of up to six per cent on the value of trust assets over the Inheritance Tax threshold once every ten years

·           an 'exit' charge proportionate to the periodic charge when funds valued above the Inheritance Tax threshold are taken out of a trust between ten-year anniversaries

These rules don't apply to trusts which are exempt from the new rules.

Inheritance Tax exemptions

There are some important exemptions that allow you to legally pass your estate on to others - both before and after your death - without its being subject to Inheritance Tax.

Exempt beneficiaries

 You can give things away to certain people and organisations without having to pay any Inheritance Tax. These gifts, which are exempt whether you make them during your lifetime or in your will, include gifts to:

·           your husband, wife or civil partner, even if you're legally separated (but not if you've divorced or the civil partnership has dissolved), as long as you both have a permanent home in the UK

·           UK charities

·           some national institutions, including national museums, universities and the National Trust

·           UK political parties

But, bear in mind that gifts to your unmarried partner or a partner with whom you've not formed a civil partnership aren't exempt.

Exempt gifts

Some gifts are exempt from Inheritance Tax because of the type of gift or the reason for making it. These include:

Wedding gifts/civil partnership ceremony gifts

Wedding or civil partnership ceremony gifts (to either of the couple) are exempt from Inheritance Tax up to certain amounts:

·           parents can each give £5,000

·           grandparents and other relatives can each give £2,500

·           anyone else can give £1,000

You have to make the gift on or shortly before the date of the wedding or civil partnership ceremony. If it is called off and you still make the gift, this exemption won't apply.

Small gifts

You can make small gifts, up to the value of £250, to as many people as you like in any one tax year (6 April to the following 5 April) without them being liable for Inheritance Tax.

But you can't give a larger sum: £500, for example, and claim exemption for the first £250. And you can't use this exemption with any other exemption when giving to the same person. In other words, you can't combine a 'small gifts exemption' with a 'wedding/civil partnership ceremony gift exemption' and give one of your children £5,250 when they get married or form a civil partnership.

Annual exemption

You can give away £3,000 in each tax year without paying Inheritance Tax. You can carry forward all or any part of the £3,000 exemption you don't use to the next year but no further. This means you could give away up to £6,000 in any one year if you hadn't used any of your exemption from the year before.

You can't use your 'annual exemption' and your 'small gifts exemption' together to give someone £3,250. But you can use your ' annual exemption' with any other exemption, such as the ' wedding/civil partnership ceremony gift exemption'. So, if one of your children marries or forms a civil partnership you can give them £5,000 under the wedding/civil partnership gift exemption and £3,000 under the annual exemption - a total of £8,000.

Gifts that are part of your normal expenditure

Any gifts you make out of your after-tax income (but not your capital) are exempt from Inheritance Tax if they're part of your regular expenditure. This includes:

·           monthly or other regular payments to someone, including gifts for Christmas, birthdays or wedding/civil partnership anniversaries

·           regular premiums on a life insurance policy (for you or someone else)

It's a good idea to keep a record of your after-tax income and your normal expenditure, including gifts you make regularly. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.

Maintenance gifts

You can also make Inheritance Tax-free maintenance payments to:

·           your husband or wife

·           your ex-spouse or former civil partner

·           relatives who are dependent on you because of old age or infirmity

·           your children (including adopted children and step-children) who are under 18 or in full-time education

If you, as an individual, make a gift in any of the situations described below and it isn't covered by one of the exemptions already described, it is known as a 'potentially exempt transfer' (PET). A PET is only free of Inheritance Tax if you live for seven years after you make the gift.

Gifts that count as a PET are gifts that you, as an individual, make to:

·           another individual

·           a trust for someone who is disabled

·           a bereaved minor's trust where, as the beneficiary of an Interest In Possession (IIP) trust (with an immediate entitlement following the death of the person who set up the trust), you decide to give up the right to receive anything from that trust or that right comes to an end for any other reason during your lifetime - see example below

Example: a wife is the beneficiary of assets in an IIP trust under her husband's will and the minor child a beneficiary of income, but the wife decides to give up any interest in the assets and these also become held in trust for the bereaved minor child.

Changes introduced by the Finance Act 2006 mean that lifetime transfers into other types of trust since 22 March 2006 no longer qualify as PETs.

·       Only 'outright gifts' count as PETs

If you make a gift with strings attached (technically known as a 'gift with reservation of benefit'), it will still count as part of your estate, no matter how long you live after making it. For example, if you give your house to your children and carry on living there without paying them a full commercial rent, the value of your house will still be liable for Inheritance Tax.

In some circumstances a gift with strings attached might give rise to an Income Tax charge on the donor based on the value of the benefit they retain. In this case the donor can choose whether to pay the Income Tax or have the gift treated as a gift with reservation.

http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/InheritanceTaxEstatesAndTrusts/DG_4016736