Who Pays Inheritance Tax: The Estate or the Beneficiaries?
4 minute read
The answer isn’t always obvious, and the way your will is written can make a real difference.
When someone dies, and inheritance tax is due, one of the first questions that arises is a practical one: who actually has to pay it? Is it the estate itself, acting through the executors? Or do the people who receive a share of the estate have to find the money themselves? The answer is not always as straightforward as it might seem, and in certain circumstances, the wrong structure in a Will can cause significant and avoidable unfairness.
This guide explains how the responsibility for paying inheritance tax is allocated, what happens when the estate and its beneficiaries are in different tax positions, and why the wording of your Will matters far more than most people realise.
Table of Contents
Who Is Primarily Responsible for Paying Inheritance Tax?
When a person dies, the legal responsibility for dealing with their estate falls to the personal representatives. These are the executors named in the will, or, where there is no will, the administrators appointed under the rules of intestacy.
It is the personal representatives who are primarily responsible for calculating, reporting, and paying any inheritance tax that is due on the estate. This is not a responsibility that falls directly on the people who stand to benefit from the estate, at least not as a first step.
The tax must be paid, and the estate must be ready to account for it, by the end of the sixth month following the month in which the person died. So if someone dies in March, the inheritance tax is due by the end of September of the same year. Importantly, this deadline often falls before probate has been granted, which can create practical difficulties in accessing funds to meet the bill.
What Does the Estate Pay Inheritance Tax On?
As a general rule, the estate is responsible for paying inheritance tax on the assets that pass through it. This covers three main categories.
- Assets passing under the will: where the deceased left a valid will, inheritance tax is payable on all assets distributed under its terms, subject to any available exemptions.
- Intestacy estates: where there is no will and the estate is distributed under the intestacy rules, the estate is still liable for inheritance tax in the same way.
- Certain lifetime gifts brought back into charge: where the deceased made gifts in the seven years before death that are now subject to inheritance tax, the estate is involved in calculating and sometimes settling the liability, depending on the nature of the gift.
Where a will exists but is silent about who should bear the cost of any inheritance tax, the position under general law is that the tax falls on the residuary estate. The residue is the portion of the estate left over after all specific gifts, legacies, and debts have been settled. In most estates, this means the residuary beneficiaries effectively bear the economic cost of the tax, even where the tax technically arises on specific gifts to other people.
The Spousal Exemption
One of the most important reliefs available in inheritance tax planning is the spouse exemption. Where assets pass on death to a surviving spouse or civil partner who is domiciled in the United Kingdom, those assets are completely exempt from inheritance tax. No tax is payable on them at all, regardless of their value.
In addition, any portion of the Nil Rate Band and the Residence Nil Rate Band that was not used on the first death can be transferred to the surviving spouse. This means that after the first death, the survivor may have access to up to twice the usual thresholds, which can substantially reduce the tax due on the second death.
However, the spouse exemption applies only to assets that actually pass to the spouse or civil partner. Where a will leaves part of the estate to non-exempt beneficiaries such as children, inheritance tax is calculated on that non-exempt portion only. The taxable and exempt portions of the estate are treated separately.
Grossing Up After Death: Why Exempt Beneficiaries Can End Up Worse Off
This is an area of inheritance tax that surprises many people, and it is one of the most important reasons why careful will drafting matters so much.
What Is Grossing Up on Death?
When a person dies, and inheritance tax is due, it is charged at 40% of the estate’s taxable value. In the most common situation, the estate bears the cost of that tax rather than the individual beneficiaries. The tax is paid out of the residue before the residuary beneficiaries receive anything.
The practical effect of this is that the tax reduces the residue. That reduction falls on whoever is entitled to the residue. And this is where things can become unexpectedly unfair.
A Common Example of the Problem
Consider a will that leaves a specific cash gift of £100,000 to the deceased’s children, and leaves the remainder of the estate (the residue) to a surviving spouse. On the face of it, this might seem straightforward: the children get their gift, and the spouse gets everything else. But if the estate has to pay inheritance tax, the picture changes.
Because the residue passes to the spouse and is exempt from inheritance tax, and the specific gift to the children is taxable, a process called grossing up applies. This is a calculation that adjusts the taxable amount to account for the fact that the estate is bearing the tax from exempt funds.
The result is that the inheritance tax bill effectively falls on the residue, which belongs to the spouse. So the spouse, despite having an inheritance tax exemption, ends up with a smaller inheritance because the tax on the children’s gift is paid from their portion of the estate. The children receive their gift in full. The exempt beneficiary is the one who bears the economic cost.
How Proper Will Drafting Solves This
This problem can be addressed directly by carefully drafting the tax clause in the will. A well-drafted will can direct that the inheritance tax attributable to any specific taxable gift should be paid by the recipient of that gift, rather than from the residue. This shifts the economic burden of the tax to the person whose gift actually gives rise to it, which is usually the fairer and intended outcome.
Without this kind of specific drafting, the default position under the law may produce a result that nobody actually wanted, and that the testator would almost certainly have corrected had they been aware of it.
The tax clause in your will can have a significant impact on how your estate is ultimately distributed. Our specialists can draft your will to ensure the tax burden falls where you intend it to. Get in touch today to discuss your requirements.
When Does a Beneficiary Pay Inheritance Tax Directly?
While the estate is the primary payer of inheritance tax in most situations, there are circumstances in which an individual beneficiary can become personally liable.
Failed Potentially Exempt Transfers
When a person makes a gift to another individual during their lifetime, that gift is initially treated as a Potentially Exempt Transfer. It becomes fully exempt from inheritance tax if the person making the gift survives for seven years. If they die within that period, the gift is brought back into the calculation of their estate.
In this situation, the person who received the lifetime gift is primarily liable for the inheritance tax on it. This can come as a surprise to someone who received a gift several years earlier and had no reason to expect a tax liability. If the recipient cannot pay, HMRC may pursue the estate as a secondary payer, but the primary responsibility lies with the person who received the gift.
Assets Passing Outside the Estate
Some assets do not pass through the estate at all but are still subject to inheritance tax. Trust assets are the most common example. Where assets held in a trust are brought into charge on death, it is typically the trustees, rather than the estate, who are responsible for meeting the tax on those assets.
Specific Direction in the Will
A will can expressly state that the inheritance tax attributable to a particular gift must be borne by the recipient of that gift. This is sometimes referred to as making the gift subject to tax. Where the will contains such a direction, the beneficiary receiving that gift is responsible for the tax relating to it, and the residue is not reduced accordingly.
Where the Estate Cannot Pay
In rare cases, the estate may not have sufficient liquid assets to meet the inheritance tax bill. Where this happens, HMRC has the power to pursue the recipients of gifts, both during lifetime and on death, to recover the outstanding tax. This is a secondary liability rather than a primary one, but it is a real risk in estates with complex structures or illiquid assets.
How Lifetime Gifts Affect the Nil Rate Band on Death
The Nil Rate Band (currently £325,000) is not applied solely to the death estate. It must first be applied to certain lifetime gifts made in the 7 years before death, which can significantly increase the inheritance tax payable on death..
How the Nil Rate Band Is Allocated
The Nil Rate Band is applied in chronological order, starting with the earliest lifetime chargeable transfers within the seven-year window. Only after those have been taken into account is any remaining Nil Rate Band applied to the death estate.
If the deceased made substantial gifts during their lifetime that used up some or all of the Nil Rate Band, less (or nothing) will be available to offset the value of the estate on death. This means a greater proportion of the estate is taxed at 40%.
Consequences for Beneficiaries of Lifetime Gifts
Where lifetime gifts reduce the Nil Rate Band available on death, the consequences depend on the nature of those gifts.
- Where the gifts were Potentially Exempt Transfers that have now failed (because the donor died within seven years), the recipient of each failed PET may owe inheritance tax on it. The amount due depends on whether any Nil Rate Band remains after earlier gifts have been accounted for, and whether taper relief applies to reduce the rate.
- Where the gifts were Chargeable Lifetime Transfers (for example, transfers into most types of trust), the trustees may owe additional inheritance tax on those transfers, because on death the full 40% rate applies rather than the reduced 20% rate that applied at the time. Credit is given for any tax already paid at the lifetime rate.
- In both cases, the death estate itself may also bear a higher tax bill than would have been the case if no lifetime gifts had been made, because less of the Nil Rate Band remains available to offset the value of the estate.
This layered interaction between lifetime gifts and the death estate is one of the most technically complex areas of inheritance tax, and it is an area where professional advice, both during life and in the structuring of a will, can make a significant difference.
If you have made significant gifts in recent years, or if your estate is likely to face an inheritance tax liability, a well-structured will is essential. Speak to our team today about how we can help.
Why the Wording of Your Will Matters
It would be easy to assume that inheritance tax is a purely financial matter, something to be managed by accountants and financial advisers. In reality, the way your will is drafted has a direct bearing on how the inheritance tax bill is shared among the people you leave behind.
The tax clause in a will, the provisions dealing with how and by whom the tax is to be paid, can determine whether a spouse ends up bearing the cost of a gift to a child, or whether each beneficiary meets the tax attributable to their own inheritance. In estates where there is a mixture of exempt and non-exempt beneficiaries, these provisions can make a difference of tens of thousands of pounds.
A will that is drafted without attention to these issues may produce an outcome that is the opposite of what the person making the will intended. Conversely, a will that is drafted with these considerations in mind can distribute both the estate and the tax burden in a way that is fair, clear, and properly reflects your wishes.
Our will-drafting specialists have extensive experience in estates with complex inheritance tax considerations. We can help ensure your will works exactly as you intend. Contact us to get started.
Frequently Asked Questions
Who pays inheritance tax when someone dies?
The primary responsibility for paying inheritance tax falls on the personal representatives of the estate, which means the executors named in the will or, where there is no will, the administrators. The tax is normally paid from the assets of the estate before beneficiaries receive their inheritance.
When does inheritance tax have to be paid?
Inheritance tax on a death estate is due by the end of the sixth month after the month of death. For example, if the person died in January, the tax must be paid by the end of July. This deadline often falls before probate has been granted, which can create challenges in accessing funds.
Do beneficiaries have to pay inheritance tax?
In most cases, no. The estate pays inheritance tax before distributing assets to beneficiaries. However, there are exceptions: where a beneficiary received a lifetime gift from the deceased and the donor dies within seven years, that beneficiary may become personally liable for the tax on the gift. A beneficiary can also be made responsible for the tax on their gift if the will specifically directs this.
Does a surviving spouse pay inheritance tax?
Generally, no. Assets passing to a surviving spouse or civil partner who is domiciled in the UK are fully exempt from inheritance tax. However, this only applies to the assets actually passing to the spouse. If other parts of the estate pass to non-exempt beneficiaries such as children, inheritance tax may be due on those shares.
What happens if lifetime gifts reduce the Nil Rate Band?
The Nil Rate Band (currently £325,000) must be applied first to any chargeable lifetime transfers made within the seven years before death. If those gifts used up some or all of the Nil Rate Band, less of the allowance is available to offset the death estate, which means a higher proportion of the estate is taxed at 40%. The recipients of failed lifetime gifts may also owe inheritance tax in their own right.
What is grossing up in inheritance tax?
Grossing up is a calculation that applies when a will leaves a specific taxable gift to one beneficiary while the residue passes to an exempt beneficiary, such as a spouse. Because the tax is normally paid from the residue, the exempt beneficiary ends up bearing the economic cost of the tax on the other person’s gift. Proper will drafting can prevent this by directing that the tax on each gift should be borne by its recipient.
Can a will direct who pays the inheritance tax?
Yes. A well-drafted Will can contain a tax clause specifying how inheritance tax is to be allocated among beneficiaries. Without such a clause, the default position is that tax falls on the residuary estate, which may not reflect the testator’s intentions. Careful drafting of this clause is particularly important in estates with a mixture of taxable and exempt beneficiaries.
What happens if the estate cannot afford to pay the inheritance tax?
If the estate does not have sufficient liquid assets to meet the inheritance tax bill, HMRC has the power to pursue the recipients of gifts made during the deceased’s lifetime. This is a secondary liability, but it is a real risk in estates with illiquid assets, such as real estate or business interests. HMRC also operates an instalment scheme for certain types of assets, allowing tax to be paid over 10 years.
Do I need a will to manage inheritance tax?
A Will does not, in itself, reduce inheritance tax, but it is the primary tool for controlling who bears the cost. Without a will, the estate is distributed under the intestacy rules, which take no account of tax planning and may result in an unnecessarily high or unfairly distributed tax burden. A professionally drafted will can ensure that both the estate and the tax liability are handled as you intend.
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Disclaimer
This article is intended as general information only and does not constitute legal advice. The information refers to the law of England and Wales. Tax thresholds and legal rules are correct at the time of writing but are subject to change. We recommend that you seek professional advice regarding your own circumstances.
Bio
This article was written by Stephen Rhodes. Stephen was called to the Bar of England and Wales in 1999 and brings over 25 years of in-house experience working with solicitor firms across the Manchester area, with a specialism in Wills and Probate. He now focuses exclusively on will drafting, helping his clients ensure their loved ones are taken care of exactly as they would wish.