inheritance tax

A tax on gifts made by an individual in the seven years before death, and on the value of assets when he or she dies. The tax rate is 40 per cent, and it applies to any amount over £263,000 for deaths on or before 6th April 2005. The calculation of HIT works as follows

1. On death, add up the value of everything the deceased owned at the time of death, including home, investments, savings, and belongings.
2. Add life assurance payments to the total
3. Deduct any debts, including outstanding mortgage amounts.
4. Deduct any bequests which are exempt from HIT (see list below)
5. Add any gifts made to third parties in the seven years prior to death which are not exempt from HIT

If the figure produced is more than the current threshold (£263,000 for deaths on or before 6th April 2005), the amount of surplus is taxed at 40% This has to be paid by the deceased's estate, except for non-exempt gifts to third parties where the tax has to be paid by the recipient of the gift on a sliding scale.

Certain types of gift are exempt from HIT. The most important of these are (a) gifts between spouses either during life or on death, which are tax-free. So if you leave your entire estate to your husband or wife, no HIT is payable, and (b) gifts to charities.

Some gifts are tax-free on death. These include lump sums paid out by a pension scheme provided the trustees have discretion about who gets the money, and refunds of personal pension contributions paid directly to a third party or to a trust but not to the deceased's estate.

And then there are 'lifetime' gifts that are tax-free or potentially tax free:

• small gifts of up to £250 to any number of people in any one tax year
• gifts on marriage to a bride or groom. Each parent can give £5,000, each grandparent and remote relative can give £2,500, and others can give £1,000.
• regular gifts out of normal income which do not affect the donor's standard of living. This covers birthday presents etc.
• up to £3,000 in other gifts in any one tax year. If this exemption is not used in one tax year, it can be carried forward to the next, but no further.

• any gifts given to an individual more than seven years before the death of the donor.

It is the last type of gift that is 'potentially-exempt'. If the donor does not live for seven years after the date of the gift, tax will have to be paid. See 'potentially-exempt transfer'.