Charitable donations and Inheritance Tax: reducing liability through philanthropy
There is a long and illustrious history of charitable giving in the UK. Back in the Victorian era, wealthy industrialists gave away large chunks of their fortunes to charitable causes and even established charitable foundations, some of which continue to function to this day. Even up to the present day, fundraising and charity drives remain a cornerstone of British life.
Many people who give to charity want to continue benefiting those good causes after they have gone. Leaving money or gifts to charity is not just a worthy legacy but can also be tax-efficient.
What is Inheritance Tax (IHT)?
Inheritance Tax is a tax levied on the estate of a deceased person. It is a tax on the transfer of assets, including money, property, and possessions, when a person passes away. It is important to stress that IHT is calculated on the value of the ‘net estate’, i.e. the aggregate value of the deceased person’s assets minus any debts they owed as at the date of their death.
There is a tax-free threshold, which is known as the "nil-rate band." As at the time of writing, this threshold was set at £325,000. If the value of the estate is below this threshold, there is usually no inheritance tax to pay. If the estate is worth more than this threshold, the excess is generally subject to taxation at a flat rate of 40%.
Some assets are exempt from IHT. For example, if you leave your entire estate to your spouse or civil partner, it is typically exempt from IHT. Additionally, there are certain exemptions for gifts made within your lifetime, such as small gifts and also any gifts to charity.
In addition to the nil-rate band, there is a "main residence allowance," which allows individuals to pass on a home to direct descendants (e.g., children or grandchildren) without IHT applying. Currently, this allowance is £175,000 per person. It is transferable between spouses and civil partners, which effectively means that a married couple or civil partners can potentially have a combined allowance of £1 million (the sum of their individual nil-rate bands and main residence allowances).
Reducing IHT by giving to charity
Gifts to charities are entirely exempt from IHT regardless of the value of the gift. While the ‘headline’ rate of IHT is 40%, your estate will be charged a reduced IHT rate of 36% by leaving at least 10% of the taxable value of your estate to charity or for philanthropic activities.
There are additional ways of reducing IHT as well as benefiting good causes, which you could consider. These include:
- Donating specific assets: You can donate assets like property, investments, or valuable personal items to registered charities during your lifetime or in your Will. These gifts are also exempt from inheritance tax, and the value of the donated assets is not included in your taxable estate.
Charitable Trusts: Setting up a charitable trust can also be a tax-efficient way to support your chosen causes. Assets placed in such trusts are generally exempt from inheritance tax. However, this is not something that you should contemplate doing without first seeking professional advice and guidance.
Gift Aid: If you are a UK taxpayer, you can increase the value of your donations through Gift Aid. When you make a donation to a registered charity and sign a Gift Aid declaration, the charity can reclaim basic rate tax on your gift. This can boost the value of your donation by 25%. While this doesn't directly reduce inheritance tax, it can still be a valuable way to support charities and potentially lower your overall estate's value.
A Will is essential
Anyone who wishes any charitable cause to benefit from their estate must make a Will. Even if you intend to leave your entire net estate to charity, you still need a valid Will in order for your wishes to take effect. Merely leaving a written letter of your wishes or making your intentions known to family or friends is not enough.
If you have a valid Will already in place, then you should periodically review it to ensure that it still reflects your wishes and circumstances. If you do have a valid Will, then you need to make one sooner rather than later. To this end, you should consult an experienced wills and probate lawyer who will be able to draft an effective Will and also advise you on your options for charitable giving and IHT mitigation.
For further information and trusted legal advice regarding Wills and Probate, get in touch with us at Carlsons Solicitors.