The average inheritance tax bill has hit a record high of £216,000 this year, with more estates being pulled under the scope of the tax.
IHT is now adding to the tax burden of ordinary middle class families when it was originally designed to be a tax on the wealthy. So how has it ended up this way?
The commonly cited first example of a tax on death is probate duty, which was introduced in 1694 as a method of raising tax to fund England’s involvement in the Nine Years War. Since then, the provisions have morphed many times over, with relatively recent examples being estate duty, capital transfer tax and now, IHT.
There are a number of factors that contribute to the increase in the average IHT bill, two of the most significant being inflation and increased house prices, which have both significantly outstripped the tax-free allowances available.
The nil rate band
The NRB is a threshold under which no IHT is payable. Any value in an estate above this amount will be taxed at the 40 per cent rate (subject to other reliefs applying).
The purpose of the NRB is to ensure that IHT is only borne by estates above a certain value, and the rate was previously set at a value aimed to exclude ordinary families. The NRB is currently £325,000 and has been fixed at this value since the 2009-10 tax year.
The Treasury announced in its 2021 budget that it will maintain the threshold of the NRB up to and including 2025-26. The resident nil rate band, which applies if a property that has at any times been the deceased's main residence passes to a lineal descendant, will also be frozen until 2025-26. The RNRB provides extra tax-free allowance on top of the NRB (currently £175,000).
The government's estimate is that by 2025-26, £445mn extra will be paid in IHT and that a cumulative total of around 12,700 additional estates will be liable to pay IHT over this period, compared with the situation if the thresholds increased in line with CPI.
Inflation has eroded the value of tax reliefs
As stated, the NRB has been fixed at £325,000 since 2009. As a result, a significant value of this tax-free allowance has been eroded through inflation.
By way of example, the Bank of England's inflation calculator shows that £325,000 in 2009 was worth £418,790.35 in 2021. Significant value of the tax-free allowance has therefore been lost, which will mean that estates that are liable for IHT will be taxed on more of their estate, resulting in a larger tax bill.
It is also worth noting that this figure is based on inflation of 2.1 per cent each year, significantly lower than the current figure of 9.4 per cent.
Rising property prices
The value of the NRB has also been eroded by the surge in property prices. It is well-known that the bulk of the value of the ordinary family's estate bound up in the family home.