Charities and Tax Saving Legacies
If you leave a gift to a charity or Community Amateur Sports Club (CASC) in your Will, its value will be deducted from your estate (your money, possessions and property) before Inheritance Tax is worked out.
Ways you can leave gifts to charity in your Will
If your estate is liable to Inheritance Tax, you could reduce the amount due by choosing to give money to charity.
You can either leave a fixed sum or part or all of your estate once other gifts have been distributed known as a ‘Residuary Legacy’. You can do this through your Will, or by a declaration to the executors giving instructions as to how you would like your legacy to be distributed.
If you are leaving money to charity, it must be clear exactly which charity you want to receive your gift.
Gifts made to a charity in the seven years before your death are exempt from Inheritance Tax.
In certain cases of gifts by Will to charity a reduced rate of IHT may apply to the estate. This means that part of the tax is payable at 36% rather than at 40%.
How the reduced rate works – In order to qualify for the reduced rate you must leave at least 10 per cent of the net value of your estate to a qualifying charity. The net value of your estate is the sum of all the assets after deducting any debts, liabilities, reliefs, exemptions and the nil-rate band.
A qualifying charity is an organisation that is recognised as a charity for tax purposes by HM Revenue & Customs. For Inheritance Tax purposes a Community Amateur Sports Club (CASC) is also treated as a qualifying charity. You can check this by asking the charity to confirm that it has an HMRC charity reference number.
There are different ways that you can own assets such as money, land or buildings and the way that you own the assets and with who affects the way they are treated when deciding whether the reduced rate of tax can apply.
To see how much you need to leave to charity to qualify or whether your estate can pay a reduced rate of Inheritance Tax because of a charitable donation left in a Will, you have to work out the value of each of the separate parts of an estate. These are known as ‘components’. It is possible that one part of your estate may pay Inheritance Tax at 36 per cent and another pay tax at the full rate of 40 per cent.
To work out whether the reduced rate applies, your estate and your assets are broken down into three components as follows:
- assets that you own jointly with someone else that pass by ‘survivorship’
- assets in trust
- assets that you own outright or as tenants in common with someone else
- see the examples below from HMRC of the relief in action
Example 1 – Only one estate component
Robert died on 17 June 2012 leaving an estate valued at £750,000 after the deduction of liabilities. He leaves £50,000 to the National Trust in his will.
Step 1 – deduct the £50,000 National Trust donation from £750,000 (the net estate). This leaves a figure of £700,000.
Step 2 – deduct £325,000 (Inheritance Tax nil rate band) from £700,000. This leaves a figure of £375,000.
Step 3 – add £50,000 (the value of the National Trust donation) back to £375,000.
This gives a figure of £425,000 – the ‘baseline amount’.
10 per cent of the estate of £425,000 is £42,500.
This estate qualifies for the reduced rate of Inheritance Tax because the charitable donation of £50,000 is more than 10 per cent of the ‘baseline amount’.
The Inheritance Tax payable will be £135,000 compared to £150,000 if Inheritance Tax was paid at the full rate.
Example 2 – One estate component with gifts made in the seven years before the death
James died on 17 July 2012 leaving an estate valued at £750,000 after the deduction of liabilities. He leaves £50,000 to the RNIB in his will. He had given £150,000 to his daughter in April 2008. Because this gift had been made less than seven years before he died it must be taken into account in working out the Inheritance Tax payable on James’s estate.
Step 1 – deduct the £50,000 RNIB donation from £750,000 (the net estate). This gives a figure of £700,000.
Step 2 – deduct £150,000 (the gift to his daughter) from £325,000 (the Inheritance Tax nil rate band). This gives a figure of £175,000.
Step 3 – deduct £175,000 (step 2) from £700,000 (step 1). This gives a figure of £525,000.
Step 4 – add £50,000 (the value of the RNIB donation) back to £525,000. This gives a figure of £575,000 – the ’baseline amount’.
10 per cent of the estate of £575,000 is £57,500. This estate doesn’t qualify for the reduced rate of Inheritance Tax because the charitable donation of £50,000 is less than 10 per cent of the baseline amount
The beneficiaries of this estate could choose to increase the charitable donation by another £7,500 by making an Deed of Variation so that the 10 per cent test is passed. This would mean Inheritance Tax could be paid at the reduced rate of £186,300 rather than £210,000. This is a tax saving of £23,700, which will cover the additional payment to charity.
Example 3 – Two or more estate components
Elizabeth died on 17 May 2012 leaving assets owned personally of £750,000 after the deduction of liabilities. Her Will stated that she wanted to leave 10 per cent of her assets to Cancer Research. She held a joint bank account with her son Andrew, which had a balance of £60,000 at death. Both contributed equally to the account so her estate also had joint property assets passing by survivorship of £30,000.The estate therefore contains a survivorship and a general component. The charity donation in the general component is £75,000.
Step 1 – deduct the donation to Cancer Research (£75,000) from the value of the general component (£750,000). This gives a figure of £675,000.
Step 2 – add the £30,000 survivorship component figure to £675,000. This gives a figure of £705,000.
Step 3 – apportion the nil rate band between the two components. Divide 675,000 (step 1) by £705,000 (step 2) and multiply by £325,000 (Inheritance Tax nil rate band). This gives a figure of £311,170.
Step 4 – deduct £311,170 (step 3) from £675,000 (step 1). This gives a figure £363,830.
Step 5 – add back in the £75,000 donation to Cancer Research. This gives a figure of £438,830 -the ‘baseline amount’.
10 per cent of £438,830 is £43,883. The general component of Elizabeth’s estate therefore qualifies for the reduced rate because she donated £75,000.
The reduced rate of Inheritance Tax means that the estate will only pay £130,978.80 compared to £145,532 if it had to pay at the full rate.
The joint account passes by survivorship to Andrew, so this component cannot qualify for the reduced rate.
Where the amount qualifying for charity exemption in one component passes the 10 per cent test, the beneficiaries of the estate may choose to elect to merge with other estate components to gain the maximum benefit from the reduced rate. The following calculation shows how this can work based on the previous example.
10 per cent of the baseline amount for the general component of Elizabeth’s estate was £43,883. So the £75,000 actually being given to charity was more than was needed to qualify for the reduced rate of tax.
It may be possible to elect to merge the survivorship component with the general component of Elizabeth’s estate so that the reduced rate of tax applies to both components. The following calculations show whether the merged components would qualify for the reduced rate of tax.
Step 1 – add the amount of the survivorship component (£30,000) to the value of the general component at Step 1 above (£675,000). This gives a figure of £705,000
Step 2 – deduct the nil rate band (£325,000) from the figure at Step 1 (£705,000). This gives a figure of £380,000.
Step 3 – add back the £75,000 donation to Cancer Research. This gives a figure of £455,000 – the ‘baseline amount’.
10 per cent of £455,000 is £45,500. The merged components of Elizabeth’s estate therefore qualify for the reduced rate as the donated amount of £75,000 is more than 10 per cent of the baseline amount.