Inheritance Tax relief on gifts to charities

Gifts to charities are exempt from Inheritance Tax ('IHT'), whether they are made during a person's lifetime or on death by their Will.

Broadly speaking, when someone dies the value of their assets above a threshold of £325,000 (the nil rate band) is taxed at 40%.  Further reliefs from IHT may apply depending on the assets of the estate.

In addition, testators are encouraged to leave more to charity by a reduced rate of IHT.  If on death 10% or more of the estate passes to charity, a reduced rate of 36% IHT will apply to the remaining chargeable assets rather than the rate of 40%.

How is the 10% gift to charity calculated?

The figure used to determine whether or not a gift qualifies the estate for the lower rate of IHT is called the 'baseline'.  This is the value of the estate after the nil-rate band and any other exemptions and reliefs have been deducted, but before the gift to charity has been made.

For example, in an estate worth £1m (of which £200,000 qualifies for business property relief from IHT), the baseline will be £1m - £200,000 - £325,000 = £475,000.  For the chargeable estate to qualify for the lower 36% rate of IHT, the gift to charity has to be £47,500 or more.

When is the 10% gift worth making?

This depends on whether or not you are already planning to leave money to charity.  The tipping point is at 4% of the estate.  If you have already decided to leave that amount or more of your estate to charity, then the relief effectively increases the value of the gift to the charity and does not cost the beneficiaries of the estate anything.

The following example will help to make this clear (for the purposes of simplicity in this example the effect of the nil rate band has been ignored).  The difference between the 4% gift and the 10% gift show that the charity receives an extra £60,000 but the family receives the same amount with HMRC paying the difference.  In between those points at 5% - 9% it is the family that pays proportionately more because the rate of IHT is still at 40%.

 

No gift to charity

4% gift to charity

7% gift to charity

10% gift to charity

Amount to charity

0

40,000

70,000

100,000

Amount to family

600,000

576,000

558,000

576,000

Inheritance Tax

400,000

384,000

372,000

324,000

Total

1m

1m

1m

1m

If, however, you are not planning to make any charitable gifts at all, leaving 10% of your estate to charity will, even when combined with the reduced IHT rate, result in your non-charitable beneficiaries receiving a smaller amount from your estate.

What if my estate includes assets I do not control?

Not everyone will be able to dispose of the whole of their estate as they wish.  Many estates will be divided into three parts: the free estate (which is the testator's to dispose of as they choose), jointly owned property (which passes to the survivor and may be IHT exempt in any case) and settled property.

It is therefore possible to make gifts in respect of each part individually, or of two or more parts combined.  If an estate combined free property worth £450,000, joint assets (passing to the survivor) worth £300,000 and settled property worth £250,000, it would be possible (depending on how the nil-rate band was allocated) to elect for a 10% legacy of £45,000 to be made out of just the free estate.  The balance of the free estate would then be taxed at 36%.

For more information on this topic, please contact Edward Porter