Q. I have been told that there is an inheritance tax relief when gifts are made to charity on death. How does the relief work?
A. The rules for the relief can be quite complicated in the case of a large complex estate, but in a straightforward case the relief takes the form of a reduction in the inheritance tax (IHT) rate from 40 per cent to 36 per cent when 10 per cent or more of the estate after deducting other reliefs, exemptions and available nil-rate band is left to charity.
A chargeable estate of £195,000 would suffer £78,000 tax at 40 per cent, but if instead the will provided for a charitable gift of £20,000, the tax would be £63,000 (£175,000 at 36 per cent). In other words, the gift has reduced the tax bill by £15,000 so the actual after tax cost of the £20,000 charitable gift is only £5,000.
The relief can be even more generous. For example, a widow dies with assets of £600,000. She leaves £25,000 to charity and the rest to her children. The estate is reduced to £275,000 by the £325,000 nil-rate band. The £25,000 charitable gift is less than 10 per cent of £275,000 so the chargeable estate of £250,000 (£275,000 less the £25,000 gift) suffers tax at 40 per cent, or £100,000, and the children receive £475,000.
If the children enter into a deed of variation and increase the charitable gift to £30,000, the gift now exceeds 10 per cent of the estate after deducting the nil rate band. A deed of variation has the effect of rewriting the will and must be entered into within two years from the date of death. The chargeable portion of the estate is now £245,000 (£275,000 less the £30,000 gift) and tax is payable at the reduced 36 per cent rate, or £88,200, and the children now receive £481,800.
To summarise, by arranging for the charity to receive an extra £5,000 the children also receive an extra £6,800. There will no doubt be some additional legal fees to pay, but the deed of variation will still be an extremely worthwhile exercise.
Ben Chaplin is managing director of Croner Taxwise
