Inheritance tax is where R03 papers separate candidates who have memorised figures from candidates who understand the mechanism. The figures are easy. The order in which gifts are brought into account, and the way the nil rate band is consumed by the oldest gift first, is where the marks hide.
The figures you must know
| Item | 2026/27 |
|---|---|
| Nil rate band | £325,000 |
| Residence nil rate band | £175,000 |
| RNRB taper threshold | £2m net estate |
| Death rate | 40%, or 36% where 10% of the baseline estate goes to charity |
| Lifetime rate on chargeable lifetime transfers | 20% if the trustees pay, 25% effective if the settlor pays |
| Annual exemption | £3,000, one year carry forward |
| Small gifts exemption | £250 per recipient per year |
| Marriage gifts | £5,000 parent, £2,500 grandparent, £1,000 other |
The three classes of transfer
- Exempt transfers, including gifts to a spouse or civil partner, charities and qualifying political parties
- Potentially exempt transfers (PETs), gifts to individuals and to bare trusts, which drop out after seven years
- Chargeable lifetime transfers (CLTs), gifts into most trusts, which are chargeable when made and revisited on death within seven years
Normal expenditure out of income is an often forgotten exemption and it is fully examinable. Regular payments from surplus income that do not reduce the donor standard of living are exempt without limit, which makes it a powerful planning point in case study answers.
Worked example
Elaine dies in October 2026 leaving a net estate of £700,000, including her home worth £400,000, all to her adult children. Her lifetime gifts were:
- June 2018: £200,000 into a discretionary trust
- May 2021: £150,000 to her daughter
- March 2024: £60,000 to her son
She had made no earlier gifts and had used no annual exemptions before these.
Step 1, order the gifts and apply exemptions
June 2018 CLT: £200,000 less two annual exemptions of £3,000 (current and prior year) = £194,000. Nil rate band available was £325,000, so no lifetime tax was due.
May 2021 PET: £150,000 less £6,000 of annual exemptions = £144,000.
March 2024 PET: £60,000 less £6,000 = £54,000.
Step 2, check which gifts fail
The 2018 CLT was made more than seven years before death, so it drops out of the death calculation. The two PETs were made within seven years, so both become chargeable.
Step 3, apply the nil rate band oldest first
The 2021 PET must take account of the cumulative total in the seven years before it, which includes the 2018 CLT of £194,000. This is the 14 year rule in action.
- Nil rate band available to the 2021 PET: £325,000 − £194,000 = £131,000
- Chargeable at 40%: £144,000 − £131,000 = £13,000, tax £5,200
- Taper relief: the gift is more than five but less than six years old, so 60% relief applies
- Tax payable by the daughter: £5,200 × 40% = £2,080
The 2024 PET has no nil rate band left, because the band is fully used by the earlier transfers in the running total.
- Chargeable at 40%: £54,000 × 40% = £21,600
- The gift is less than three years old so no taper relief applies
- Tax payable by the son: £21,600
Step 4, tax the death estate
The nil rate band has been consumed by the failed PETs, so nothing remains for the estate. The residence nil rate band of £175,000 is available in full, because the net estate is below the £2m taper threshold and the home passes to direct descendants.
- Taxable estate: £700,000 − £175,000 = £525,000
- Tax at 40% = £210,000
Step 5, state who pays what
| Party | Tax |
|---|---|
| Daughter, 2021 PET | £2,080 |
| Son, 2024 PET | £21,600 |
| Estate | £210,000 |
The examiner awards marks for identifying who bears each amount. Tax on a failed PET falls on the recipient in the first instance, and only becomes an estate liability if they do not pay.
Taper relief table
| Years between gift and death | Relief on the tax |
|---|---|
| 0 to 3 | Nil |
| 3 to 4 | 20% |
| 4 to 5 | 40% |
| 5 to 6 | 60% |
| 6 to 7 | 80% |
Two exam warnings. Taper relief reduces the tax, never the value of the gift, and it is useless if the gift falls within the nil rate band because there is no tax to reduce. Candidates who taper the gift value rather than the tax lose the whole question.
Transferable bands
A surviving spouse can claim the unused proportion of the deceased partner nil rate band and residence nil rate band. It is a percentage claim, not a cash amount, so a spouse who died in 2004 having used none of their band passes on 100%, worth £325,000 at today rate. The claim must be made within two years of the second death.
Reliefs and reporting
- Business relief at 100% or 50% on qualifying business assets held for two years
- Agricultural relief on the agricultural value of qualifying land
- Quick succession relief where the same assets are taxed twice within five years
- IHT is due by the end of the sixth month after death, and instalments over ten years are available on land, some business assets and controlling shareholdings
Where candidates go wrong
- Applying the nil rate band to the most recent gift instead of the oldest
- Ignoring the 14 year rule and leaving out a CLT that sits before a failed PET
- Tapering the gift rather than the tax
- Forgetting that the residence nil rate band is capped by the value of the home and needs direct descendants
- Missing the two available annual exemptions when a gift is the first in a sequence
Write out the five step order, practise it on three different gift patterns, and IHT changes from the topic you skip to the one you hope comes up.