All gifts made to charity whether during your lifetime or in your Will – are exempt from Inheritance Tax (Section 23 Inheritance Tax Act 1984). The size of the gift makes no difference and some wealthy people do choose to make substantial gifts to charity during their lifetime which (unlike lifetime gifts to friends and family) do not impact their Inheritance Tax position.
Others decide to leave a gift in their Will – for example, a straight gift (“I give £1,000 to St John’s Ambulance”) or a gift of their residue. They might, for example, give their children the income from their assets for life with the remainder to charity (although careful consideration should be given as to whether this income is substantial enough to be of value, particularly where the beneficiary is maintained by the Testator financially).
Note that if a Deceased person did not leave a gift to charity but the beneficiaries of the Deceased person’s estate wish to alter this position, they can do so within 2 years of the death using a Deed of Variation. This is treated as being ‘read back’ into the Will (in other words, as if the replacement words in the Deed were actually written by the Testator) and the estate will then benefit from any Inheritance Tax reduction available.
Facts and figures
In 2018 British charities received over £5 billion through gifts in wills and in-memory motivated giving. That’s a tenth of total charitable income, and this figure is on the up.
Over the past 25 years, legacy incomes have more than doubled in real terms and Legacy Foresight predicts in the next 25 years legacy incomes will almost double again, reaching £5.9 billion at today’s prices by 2045.
The share of estates gifts to charities – which has been sitting at 3% for decades has climbed to 4%.
Source: Legacy Foresight
Basic Inheritance Tax allowances
Everyone gets a standard Inheritance Tax allowance – currently £325,000. Gifts between spouses and civil partners are exempt from Inheritance Tax and do not use up the allowance. Any unused allowance on the first death can be claimed by the survivor’s estate on the second death. Couples therefore have a basic allowance of £650,000 to pass on between them.
More recently, the Residence Nil Rate Band has introduced a further allowance whether the estate includes a property that has been the Deceased’s residence and this is left to a ‘direct descendant’. This is currently £150,000 each and will increase to £175,000 in the 2020/21 tax year. Couples will therefore potentially be able to leave up to £1 million tax free to their children on the second death.
Anything over the allowances is taxed at 40%. Lifetime giving is also taken into consideration when calculating the tax (find out more here).
Reducing the Inheritance Tax rate from 40% to 36%
Where the Deceased died on or after 6th April 2012, a reduction from 40% (the standard Inheritance Tax rate) to 36% is available where the Deceased leaves enough of their estate to charity (Section 209 and Schedule 33 of the Finance Act 2012 which inserts a new Schedule 1A into the Inheritance Tax Act 1984).
Of course, gifts to charity are exempt from Inheritance Tax so if the Deceased left their entire estate to charity, there would be no Inheritance Tax to pay. However, the new provisions offer an incentive to those whose estates are likely to exceed the Inheritance Tax thresholds and who might leave a slightly smaller but nonetheless generous gift. They mean that sometimes gifting a little more to charity can mean the other beneficiaries receive more.
Generally speaking the reduced rate of Inheritance Tax will be available where 10% of the net estate (known as ‘the baseline amount’) is left the charity. NB. Practitioners believe that any Residence Nil Rate Band available should be ignored when calculating the baseline amount (so this will be of interest to anyone whose estate is likely to exceed the basic Inheritance Tax allowances). However, we are not aware of any HMRC guidance confirming this point, as yet.
If the Deceased’s estate did not contain any property passing by survivorship or any trust property that he is deemed to own then it is very easy to calculate the baseline amount – it is simply the value of the estate, less the funeral expenses and debts, taking into account any exemptions and reliefs and the basic nil rate band (Inheritance Tax allowance).
So, for a simple example:
James dies leaving assets worth £1,000,000 in his sole name.
His debts and funeral expenses total £10,000.
He leaves £60,000 to Oxfam and the rest to his son George.
He does not make any chargeable transfers in the seven years prior to his death.
Assume for this calculation that the RNRB does not apply. The ‘baseline amount’ is:
£10,000 funeral expenses and debts
£325,000 available nil rate band
Baseline amount = £565,000
Because the gift of £60,000 is at least 10% of the net estate (the baseline amount), the reduced 36% Inheritance Tax rate applies.
To calculate the tax payable:
Debts and funeral expenses £10,000
LESS exemptions (charity) £60,000
Chargeable estate £830,000
First £325,000 @ 0% (nil rate band – i.e. Inheritance Tax allowance)
£505,000 @ 36%
Total tax £181,800
Amount to charity £60,000
Amount to son George £648,200
If the gift left to charity did not amount to 10% of the net estate – for example, if it was just £40,000 – the Inheritance Tax due would have been £525,000 x 40% = £210,000 and George would have received just £640,000. So if you are thinking of making a gift to charity in your Will that is around the 10% mark anyway, it makes sense to ensure the amount is always 10% or more – otherwise the remaining beneficiaries may lose out.
When drafting your Will it won’t be possible to state an exact amount if you want to be certain that the 10% requirement is met, so instead it is more sensible to use a formula. We can insert a suitable clause in your Will for you.
If a relative has died and just missed the 10% mark, remember that it’s possible to make a post-death Deed of Variation which ‘writes back’ the terms of the deed into the Will. This could leave both the Deceased’s chosen charity and their other beneficiaries better off.
Estates including trust property / property passing by survivorship
Calculating the baseline amount is more difficult if the estate includes:
(a) property that passes by survivorship – for example, if a house was owned as ‘joint tenants’, the house automatically passes to the survivor on the first death; and/or
(b) property that is held within a trust where the Deceased was deemed, for Inheritance Tax purposes to own the capital. This is the case where the Deceased had a life interest – so for example, if Julie is given the right to live in ‘Greenacre’ for life with the remainder to her sister, on her death the value of Greenacre will be notionally included in the total value of her estate when calculating Inheritance Tax – even though she never actually owned it; and/or
(c) property that has been gifted where a reservation of benefit has been retained. For example, if you give your house to your children but continue to live in it, this will be treated as forming part of your estate for Inheritance Tax purposes, even though you do not legally own it any more.
(d) ‘general property’ that does not fall into the above categories.
Where the estate includes any of the above, the estate is divided into three components – (i) the survivorship property, (ii) the trust property and (iii) the general property – and the components are looked at separately (Paragraph 3 to Schedule 1A). If at least 10% of a component is left to charity, the 36% reduced Inheritance Tax rate is available for the rest of the component (Paragraph 2(1) of Schedule 1A).
Merging the components
To add a further layer of complication, where an estate is made up of more than one component, the nil rate band (Inheritance Tax allowance) has to be apportioned between the different components. It is possible to elect to merge the components and treat all the merged property as one for the purpose of the 10% net value test. This would likely be useful where a large proportion of one component was left to charity – if significant enough, it may attract the reduced rate on the whole of the merged value.
Gifts with a reservation of benefit (GROBs) do not automatically fall into any of the three components. They will be treated as if they were still owned by you for Inheritance Tax purposes and cannot benefit from the reduced 36% rate unless an election is made to merge. We will not delve further into the rules on merging as they are quite complex but simply put, if at least 10% of one of the three components above is left to charity, it may be possible to merge the components with the value of the GROBs to benefit from the lower tax rate. If, once merged, the 10% test is met, the lower rate of IHT applies.
If you are considering making a gift to charity that is in the region of 10% of your net estate, we can insert a clause to ensure that the gift meets the 10% requirement, in order to benefit from the reduced rate of Inheritance Tax (should your estate be liable for tax).
To gift on death or during one’s lifetime?
A number of schemes exist which make charitable lifetime giving tax effective. These include tax relief through Gift Aid or straight from your wages or pension through Payroll Giving. These are especially attractive to higher rate tax payers.
Disclaimer: This article is intended to be a general overview of Inheritance Tax in relation to charitable gifts. It is not a substitute for professional advice on your individual circumstances.