A familiar grievance was highlighted in a recent Times Money ePoll when inheritance tax (IHT) was voted the second-most-hated tax in Britain (after council tax) by readers. One of them, JC, summed up the mood, commenting: “IHT is a tax on families who work hard and save and is not fair.”

With signs that the Revenue is tightening the rules, we explain them — and show how to reduce your bill.

The rules

IHT is charged at 40 per cent on all the assets that you leave above the nil-rate band, currently £325,000. However, the tax is not payable when an estate passes between a husband and wife, or from one civil partner to another. Moreover, spouses and civil partners can transfer the unused part of their tax-free allowance to the survivor. So, the heirs of a widow who inherited all of her husband’s money would have to pay inheritance tax only on assets above a combined total of £650,000.

The tax is also payable on certain gifts made within seven years of death. Details are online at www.direct.gov.uk and www.hrmc.gov.uk, and you can call the Revenue’s probate and inheritance tax helpline on 0845 3020900.

Action before death

If you believe IHT will be payable on your or a relative’s estate, action now could save money. Peter Nellist, a partner at Clarke Willmott, the solicitor, says that the key is to keep things simple. He adds: “The easiest way around the tax by far is to make gifts during your lifetime.”

All gifts made seven or more years before a death are potentially exempt transfers (Pets) and free of IHT. Where someone makes a gift and dies within seven years, the tax is payable — at the full 40 per cent if death is within three years, and on a sliding scale if between three and seven years.

It is possible to buy special insurance to cover the tax if you should die within seven years of making a gift. Mr Nellist says: “A healthy couple in their fifties who want to make a gift of a house, for example, could buy £1 million of joint-life and survivor whole-of-life cover for about £30 a month. If both of them die within seven years, their children’s IHT is covered in full.”

Certain gifts are clear of the tax, regardless of when they are made, including all gifts or bequests to charity.

You can gift up to £3,000 a year free of IHT — or £6,000 if you made no gifts the previous tax year. A couple who made no gifts last year could therefore reduce their liability by £12,000 with one gift to their children. This is your “annual exemption”. Gifts of up to £5,000 on a wedding or civil partnership may also be exempt.

A second allowance is the “small-gifts exemption”, which lets you make gifts of up to £250 to as many people as you like in any tax year. Note, however, that you cannot combine the two allowances to give one person £3,250.

More significantly, regular gifts from income are exempt from the tax, whatever their size, provided they do not affect your standard of living. The Revenue is likely to demand proof of the nature of such gifts. Mr Nellist says: “Many older couples picked up the savings habit young and are still saving. They have a good deal of income, which they can afford to give away — while their children and grandchildren have expenses like mortgages and student loans.”

There are also a number of ways to reduce IHT by setting up trusts. A discretionary trust is effectively a gift — the donor must live seven years to avoid the tax — but it enables trustees to keep control of the money, preventing beneficiaries from splurging on holidays or fast cars, for example.

Anyone who expects considerable sums to be payable on their estate should consult a solicitor who specialises in IHT. Mr Nellist advises people to visit two or three firms for an initial chat. Be aware that there is no need for you to nominate the solicitor who drafts your will as its executor. Naming your child sole executor gives him or her the option of choosing a solicitor to handle the administration.

Independent financial advisers can also advise on IHT planning. There is tax relief on agricultural property, for example, although the rules are complex and could suddenly change.

After a death

A proactive approach after a death can significantly dent an IHT bill. If it looks like there is a good deal of tax to pay, your first stop should be a good solicitor. He or she will be able to spot any loopholes and help you to negotiate with the Revenue. Mr Nellist gives the example of a couple whose children were able to establish that, contrary to a challenge from the Revenue, gifts from their parents totalling £70,000 had been regular gifts from income, and not a deathbed scheme, and were therefore exempt from IHT. This saved the estate £28,000 — for legal costs of about £3,500 plus VAT.

Interestingly, a little-known “deathon-active-service provision” offers IHT exemption to the estates of a large number of war veterans. The provision exempts anyone who dies prematurely as a result of an injury sustained on active service. In the best-known example, the heirs of the 4th Duke of Westminster showed that his death from cancer in 1967 had been hastened by septicaemia in a war wound.

The good will guide

If you do not make a will, your estate will be distributed according to intestacy law, rather than your wishes. This could mean that your money is left to other relatives as well as your spouse — creating unnecessary IHT liability.

Be aware that marriage revokes a will. This can cause problems where a man remarries, as any children from the first marriage may receive less than expected.

Solicitors provide IHT advice as part of their will-writing service. The quality will vary, so be sure to shop around. The Law Society can direct you to specialist firms in your area. Call 0870 6062555.