The Office of Tax Simplification (OTS) recommends that inheritance tax rules are changed to make them easier to understand. The Chancellor commissioned this investigation by the OTS last year.

What is inheritance tax?

Inheritance tax is a tax on the estate of someone that has passed away, if certain conditions are met.

‘Estate’ means money, property and possessions that are left by the deceased.

There is also a subsection of inheritance tax regulations that lay out the tax due on gifts given before a person dies, if they are within seven years of that individual’s death.

Who pays inheritance tax?

If the estate is worth over £325,000 in total, you are liable to pay inheritance tax. Unless it is left to a spouse, civil partner, community amateur sports club or charity – then there is no inheritance tax to pay.

Only 5% of all deaths result in the payment of inheritance tax, that’s about 25.000 per year. The current systems requires ten times that amount of people to complete paperwork to determine their potential liability.

The rules are tricky and generate extra worry at an already difficult time of bereavement.

As reported by the BBC, the OTS Chair, Kathryn Cearns, said: “Although only a small number of people pay inheritance tax each year, a far greater number worry about it. The OTS’s packages of recommendations would go some way to achieving the goal of making the tax easier to understand and simpler to comply with.”

When do you have to pay inheritance tax on a gift?

This is an even more complicated set of rules. At the moment, you can give away the following amounts of your own money without being liable for inheritance tax:

  • £3,000 each tax year – can carry over to the next tax year, making that allowance up to £6,000
  • Additional £250 to any other person
  • Separate allowance for gifts designated for wedding costs
  • If the money is earned income and not savings, it is not usually considered liable for inheritance tax

The amount of tax payable is on a sliding scale, based on how many years pass between giving a gift and death.

  • 7 years before death: 0%
  • 6-7 years before death: 8%
  • 5-6 years before death: 16%
  • 4-5 years before death: 24%
  • 3-4 years before death: 32%
  • Under 3 years before death: 40%

As you can see, this really does add to the confusion of the regulations. The cost of this could fall on the recipient of the gift, if the giver dies within seven years and gives away over £325,000. Otherwise, it is usually the estate itself that is liable for the inheritance tax bill.

What are the OTS proposing?

In terms of gifts, the OTS suggests cutting this deadline to five years, at least eliminating the nightmare of trying to locate seven year old paperwork.

Although some people think that this could mean some recipients of gifts could end up paying higher inheritance tax bills.

Laura Suter, of AJ Bell, said: “The suggestion of reducing the seven years down to five and scrapping taper relief entirely looks like a bald tax grab and revenue-raising move. Instead the taper could be simplified into a two-step process, for example, or if it is scrapped entirely then the period should be shorter than five years.”

Rather unsurprisingly, they advocate a simplification of the inheritance tax rules as a whole, with some specific findings.

They suggest altering Capital Gains Tax rules, which currently isn’t payable on death. Some people think that this discourages people from handing down their assets while they are still alive.

It is noteworthy that they have not mentioned the murky waters of bequeathing the family home.

The Treasury are not bound to implement any of the findings and have said they will “consider the OTS recommendations carefully and will respond in due course.”