The practicalities of paying inheritance tax

There can be a temptation in inheritance tax planning to focus only on the absolute value of inheritance tax that is expected to be payable, without giving thought either to the timing or the practicalities of paying that tax. Following a death and at the start of a discussion about the probate process, that focus fairly immediately shifts to how, and from where, that inheritance tax might be funded.

The problem lies in the order of events:

Firstly, the inheritance tax position must be established and the inheritance return filed
Then, the inheritance tax must be paid
Only then can probate be applied for
Only once probate is granted can executors eg. close the bank accounts of the deceased/sell or transfer assets like houses and investments and so on.

This has the potential to create a classic catch-22; you can’t pay the tax until you sell the asset and can’t sell the asset until you’ve paid the tax.

How this can be managed

Happily, there are a series of ways in which the process can be managed.

Direct Payment Scheme: There is an established scheme whereby instruction can be given to mainstream/high street banks to pay inheritance tax directly to HMRC out of otherwise frozen bank accounts of the deceased.

NS&I equivalent: There are similar, albeit less streamlined, processes enabling executors to have tax paid out of NS&I holdings of the deceased.

Instalment option: Where part of the tax is payable on (most commonly) land and buildings or private company shares, it is possible to elect with HMRC to pay that part of the inheritance tax in 10 equal annual instalments rather than having to pay all the tax up front.

To provide an example, if:

the total estate is £3m and land and buildings account for £2m of that value
the total tax is £850,000

Then:

£2m / £3m = 67% the tax is eligible for instalments whilst the other 33% is not eligible for instalments.

So rather than the executors having to find £850,000 of tax up-front, they need to find:

(£850,000 x 33%) + ((£850,000 x 67%) / 10) = £337,450

In this way there is much less need for liquidity in the estate in order to fund the up front tax bill.

There is a cost to the instalment option, in that interest is payable on the unpaid instalments, currently at 7.75%.

Usually the instalments are used to overcome the cashflow hurdle of obtaining probate and then assets are sold to generate cash, with the remaining instalments then paid off early.

Borrowing

If all of the above still leaves executors short, there is the option of borrowing to pay the inheritance tax bill.

Commercial borrowing can be both difficult to obtain and costly, but sometimes the executors or beneficiaries will be willing to make a short term loan and sometimes a loan from a family business might be possible.

Grant on a credit

As a last resource (although following a recent Budget announcement, it is no longer necessary to show HMRC that commercial borrowing has been unsuccessfully sought before pursuing this route) the executors can go cap in hand to HMRC for a ‘grant on a credit’.

Essentially this is a plea for HMRC to accept that the executors have done all they can to pay the tax but have come up short, coupled with a promise to pay the remaining tax out of specific assets which can be accessed once probate has been obtained.

If accepted, HMRC will give the executors the necessary evidence of having dealt with their tax obligations such that the executors can proceed with the extraction of the grant despite a shortfall of tax still existing.

As Chartered Accountants, tax advisors and persons regulated to carry out non contentious probate work in England and Wales we are ideally placed to help with every part of the inheritance tax process. From lifetime planning to minimise exposure through to the post death reporting and payment of the tax charge arising, whilst also taking a holistic view of the broader tax environment for the executors and beneficiaries/family members.