Charitable gifts can work to reduce the IHT payable in two ways:
- reducing the value of the net estate chargeable to IHT; or
- where the gifts to charity are worth at least 10% of the net estate at death, reducing the rate at which inheritance tax is payable.
Lifetime gifts and bequests on death made to qualifying charities and registered housing associations are exempt from inheritance tax, provided that the gift was made outright.
A qualifying charity is one that meets the following conditions:
- it is a charity that is established in the EU or other specified country;
- it meets the definition of a charity under the law of England and Wales;
- it is regulated in the country of establishment, if that is a requirement of that country;
- its managers are fit and proper persons to be managers of the charity.
HMRC assumes that people appointed by charities are fit and proper persons unless they hold information to show otherwise.
Reducing the net estate
Where a gift is made to charity, the net estate is reduced by the amount of the gift. This can be effective in reducing the amount of inheritance tax payable where the value of the estate exceeds the nil rate band (currently £325,000), plus the residence nil rate band, where available.
The gift to charity reduces the net value of the estate.
Elsie died on 1 December 2018 leaving an estate worth £475,000. She had never married and had no children. In her will she left £5,000 to a qualifying charity, and the balance of her estate to her niece Susan.
Her total estate of £475,000 is reduced by the charitable gift to £470,000. After deducting her nil rate band of £325,000, her taxable estate is £145,000 (on which IHT of £58,000 (£145,000 @ 40%) is payable. The charitable gift reduced the IHT payable on her estate by £2,000 (£5,000 @ 40%).
A reduced rate of IHT
Where the charitable gift is at least 10% of the net estate, the rate of inheritance tax is reduced from 40% to 36%. The net estate is the value of the estate after deducting any debts, liabilities, reliefs and exemptions and the nil rate band and residence nil rate band, as appropriate.
Alfred died on 20 October 2018. He left an estate of £700,000. He had never married and had no children. In his will he left £40,000 to a qualifying charity, with the balance of his estate split equally between his three nephews.
£700,000 Total estate
(£40,000) Less: qualifying donation to charity
(£325,000) Less: nil rate band
£335,000 Taxable estate
The value of the estate in excess of the nil rate band is £375,000 (£700,000 – £325,000). This is the baseline amount. The qualifying donation to charity of £40,000 is more than 10% of this amount. Thus, the rate of inheritance tax on the taxable estate is reduced from 40% to 36%.
Consequently, the inheritance tax payable on Alfred’s estate is £120,600 (£335,000 @ 36%).
Where the residue of the estate is partially exempt, for example if it left to a surviving spouse or to a charity, and the Will contains other legacies are left free of tax, it is necessary to gross up such legacies when testing whether the 10% test is met. HMRC produce a calculator which can be used to check whether the test is met. It is available on the Gov.uk website at www.gov.uk/inheritance-tax-reduced-rate-calculator.
Why not give the Bedrock team a call today to discuss the implications for your estate planning?