When someone dies in the UK or many other countries, their estate may be taxed. In most cases, the tax due is Inheritance Tax (IHT), which the deceased’s family pays on their ‘inheritance.’ However, if the deceased’s estate is substantial and includes overseas investments or properties, a family business, or anything else that ‘earns’ an income, Capital Gains Tax (CGT) may be levied.

The amount of probate tax a family pays on a deceased’s estate is largely determined by its total value. The estate includes any life insurance policy payouts, investments, rental properties, and cash in the bank. If the value of the deceased’s estate is less than HMRC’s tax threshold, the estate may be exempt from paying probate tax.

Furthermore, the reporting of IHT has been simplified as a result of changes to the way Inheritance Tax is calculated beginning in January 2022. So, how much probate tax do you pay in the UK?

What is Inheritance Tax and Capital Gains tax on probate?

Inheritance Tax is a tax levied on the value of a deceased person’s estate. The deceased’s beneficiaries/family must pay 40% tax on the estate’s value over and above the £325,000 UK IHT tax threshold.

For instance, if the deceased’s estate is worth less than £325,000, no IHT is due to HMRC. However, if the deceased’s estate is worth £400,000, the beneficiaries/family/executors will be taxed on the amount above the tax threshold, which is £75,000.

On the transfer of assets to beneficiaries, capital gains tax is usually not required. However, any assets acquired by the deceased’s estate after death may be subject to CGT; this is a tax on ‘gains’ that is typically associated with residential property but can also apply to investments and businesses. This means that when the beneficiary or executor sells or transfers the asset, CGT is due on the ‘gain’ in the asset’s value between the date of the deceased’s death and the date the asset was sold or transferred.

For example, if the deceased’s property was worth £200,000 at the time of death but had increased to £250,000 by the time it was sold, the estate (beneficiaries or family) may be required to pay CGT on the ‘gain’ of £50,000.

What is the Inheritance Tax threshold?

Currently, there is only one threshold of £325,000. This is known as the ‘nil-rate band,’ and an estate valued below this threshold is exempt from probate tax. Estates worth more than the threshold are subject to 40% Inheritance Tax. As an example, consider the following:

If your estate is worth £600,000, your IHT is calculated as follows:

£600,000 – £325,000 = £275,000

£275,000 x 40% = £110,000 probate tax due

As a result, the deceased’s beneficiaries receive £325,000 plus £165,000 (the estate’s remaining value after taxes are paid), for a total of £490,000.

There are, however, a few of circumstances in which the Inheritance Tax threshold is different.

• Married and civil partnerships: If one partner dies before the other and you leave your entire inheritance to your spouse or partner, there is no tax due and, in most situations, the nil rate band threshold is unaffected as well if you are married or in a civil partnership. This implies that the surviving spouse can effectively double their threshold after they pass away by adding the remaining portion of their deceased partner’s/threshold spouse’s to their own. Inheritance tax is owed, and a portion of the zero rate band threshold may be withdrawn, if the spouse or partner leaves a portion of their estate to other beneficiaries, such as children, or made a lifetime gift seven years before to their death and the estate is of sufficient value.
• If you are married or in a civil partnership and you leave your family home to your surviving spouse or a direct descendent, such as a child or grandchild, in its entirety, there is currently an additional £175,000 tax-free allowance available, but only if the property’s value is less than £1 million. Anything exceeding this point results in a considerable reduction in the allowed. The good news is that any remaining tax allowance can be added to the allowances of the surviving spouse upon death.

Do spouses and civil partners have to pay a probate tax?

There is typically no estate tax to pay for a married person or a civil union partner. Surviving partners can carry over any unused tax-free allowance to their own tax returns. Therefore, in practise, a surviving husband or partner does not have to pay any probate tax on an inheritance up to £650,000, or £1 million if it includes a property.

The above does not apply, however, if the deceased spouse/partner spent most or all of their tax-free allowance by leaving a portion of their assets to a direct descendant.

Tax-free gifts and trusts

It is possible to make tax-free gifts to spouses/partners or charities, but this depends on when the gift is made. There will be no tax to pay on the gift if it was given at least seven years before death and was not given to a business or a trust. However, if the person dies before the seven-year period, a tax levy must be paid, and the amount depends on when the person dies during that period. IHT taper relief on potentially exempt transfers is what this is called (PETs).

It is also possible to place assets in a trust that will be passed on to a beneficiary after death. While a trust does not exempt the estate from paying probate tax, it can help to reduce the amount of Inheritance Tax paid. This is because any assets held in a trust and managed on behalf of the beneficiaries by appointed trustees are owned by the trust, not the trustees or the person who established the trust. If you live for more than seven years after the trust is established, the assets are not included in your estate upon death and may be tax-free. Instead, a 20% IHT tax levy is imposed when the trust is established, and the assets are revalued every ten years, and 6% IHT is paid at that time, minus the nil rate band threshold of £325,000.

When making a will, it is critical to first understand the tax implications for your beneficiaries, family, and executors.