In brief: The Inheritance Tax threshold is £325,000 in tax year 2010/11, and until 2015. Below this is the "Nil rate band." Above this amount tax is paid at 40%. Where a spouse dies the benefit of the unused Nil rate band can be passed on.
More details below..
The law allows you to leave an estate worth up to £325,000 (2010/11-15) without having to pay any Inheritance Tax upon it. This £325,000 is called the 'Nil Rate Band'. After the first £325,000, or the Nil Rate Band, the remainder of your estate will be charged 40% Inheritance Tax.
Since 9 October 2007, spouses and civil partners can transfer their Nil Rate Band allowances so that any part of the Nil Rate Band that was not used when the first spouse or civil partner died is transferred to the individual's surviving spouse or civil partner for use on their death.
The transferable allowance is available to all survivors of a marriage or civil partnership, no matter when the first partner died/dies.
The increased Nil Rate Band does not replace the single Nil Rate Band available to the survivor that determines whether or not their estate is an excepted estate.
How the transfer works:
Where a valid claim to transfer unused Nil Rate Band is made, the Nil Rate Band that is available when the surviving spouse or civil partner dies will be increased by the proportion of the Nil Rate Band unused on the first death. For example, if on the first death the chargeable estate is £150,000 and the Nil Rate Band was £300,000, 50% of the Nil Rate Band would be unused. If the Nil Rate Band when the survivor dies is £325,000, then that would be increased by 50% to £487,500.
The amount of the Nil Rate Band that can be transferred does not depend on the value of the first spouse or civil partner's estate. Whatever proportion of the Nil Rate Band is unused on the first death is available for transfer to the survivor.
Examples of how the rules work:
Example 1. Andrew died on 14 April 2007 with an estate of £400,000, which he left entirely to his spouse, Barbara. Barbara died on 17 June 2009 leaving an estate of £600,000 equally between her two children. When Barbara died the Nil Rate Band was £325,000. As 100% of Andrew's Nil Rate Band was unused, the Nil Rate Band on Barbara's death was doubled to £650,000. As Barbara's estate was £600,000 there was no IHT to pay on Barbara's death.
Example 2. Jane died on 27 May 2007, with an estate of £300,000. She left legacies of £40,000 to each of her three children with the remainder to her spouse Keith. The Nil Rate Band when Jane died was £300,000. Keith died on 15 September 2009 leaving his estate of £500,000 equally to his three children; the Nil Rate Band when Keith died was £325,000. Jane used up 40% of her Nil Rate Band when she died, which means 60% was available to transfer to Keith on his death. So Keith's Nil Rate Band of £325,000 was increased by 60% to £520,000. As Keith's estate was only £500,000 there was no IHT to pay on Keith's death.
Example 3. Roy died on 14 April 2007 with an estate of £450,000, which he left entirely to his spouse, Sheila. Sheila died on 17 June 2009 leaving an estate of £675,000 which she left equally between her two children. When Sheila died the Nil Rate Band was £325,000. As 100% of Roy's Nil Rate Band was unused, the Nil Rate Band on Sheila's death was doubled to £650,000. This left £25,000 chargeable to IHT on Sheila's death.
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