How granny’s diamond ring could land you with an inheritance tax shock

The tax tops polls as the most hated in Britain. So it’s no wonder families want to keep their inheritance tax (IHT) bills to an absolute minimum.

But research shows more than 4,000 bereaved families were investigated by HM Revenue & Customs last year over suspicions of underpaid death duties.

The taxman handed out a £326 million bill for IHT payment errors in 2021/22 — up 28 per cent on the previous tax year.

The figures, contained in answers to a freedom of information request by insurer NFU Mutual, show HMRC is getting tougher on families who either misunderstand complex IHT rules — or try to avoid paying.

So could you find yourself at the centre of an inheritance tax probe? And how do you avoid getting caught out by the tangled web of rules?

Taxman gets tough on missing dues

An estimated 684 additional families were investigated in the last tax year compared with the one before.

Even some of the most diligent, with carefully crafted succession plans, were forced to cough up after being probed.

HMRC says it will dedicate a larger number of officials to investigating inheritance tax payments this year.

Mistakes are becoming more common as a greater number of assets exceed the tax-free thresholds for passing on wealth.

The first £325,000 of someone’s assets can be bequeathed tax-free. Above this level, all assets are taxed at 40 per cent. The £325,000 nil-rate threshold has been frozen since 2009 and won’t rise for at least five more years.

There is an additional allowance of £175,000 when the family home is left to ‘direct descendants’, such as children or grandchildren.

Spouses or civil partners do not generally need to pay any tax on transferred assets.

> Keep your wealth safe from the taxman: Ten ways to avoid inheritance tax legally 

Tracking down hidden wealth

HMRC will study any sources of information about your family finances it can get its hands on.

Everything from fine art to diamond rings — often forgotten or excluded from an estate — tend to leave a paper trail. One of the most vital is on your insurance documents.

HMRC has access to huge amounts of personal information via a database called Connect, according to Robert Levy, a specialist in tax investigations at law firm Kuits Solicitors.

‘They tend to have all your property details, bank accounts and insurance policies, so they can build a pretty clear picture of your finances,’ he says.

If IHT payments your family have made don’t match HMRC’s own forecasts of what is due, it will start asking questions.

Allowance: The first £325,000 of someone’s assets can be bequeathed tax-free. Above this level, all assets are taxed at 40% 

An investigation can take months, and even years to complete, as officials search for undisclosed assets. There is no limit on how long the taxman has to open an investigation.

However, you will typically be told within three months of paying IHT if you are facing investigation. ‘Usually, if they are going to engage they will do it quickly,’ Mr Levy says.

‘You would receive a letter with a list of questions for evidence of valuations or queries about an asset you haven’t disclosed.’

In many cases, there may be a legitimate reason for the shortfall. For example, the deceased may have spent the money HMRC thinks they had, or their investments might have lost value and HMRC didn’t have up-to-date accounts. Or certain items have simply been forgotten in totting up an estate.

‘In some cases, there is a painting on the wall that no one has thought about.

‘If it’s worth a lot of money, chances are it is insured, so it will be on HMRC’s radar. They’ll come after it,’ Robert Levy says.

Keep a record if you ‘gift it’

One of the biggest areas of contention between HMRC and families is gifts. You can give assets to friends or family to potentially reduce IHT bills: from furniture and jewellery to antiques and cash.

However, the gift is tax-free only if it was handed over more than seven years before death.

Keep a record of what you give, to whom, when it was handed over — and its value. Otherwise it’s up to your family to provide proof that the gift was made more than seven years ago.

Mr Levy says: ‘Jewellery tends to be easy to “accidentally forget” in the hope it goes unnoticed. But often, each item is insured so HMRC has records of it. It is difficult to argue it was gifted if it’s on the deceased’s insurance.’

The solicitor says in one case, a wealthy family failed to list any jewellery on the inheritance tax form. 

A £10,000 diamond ring was among items on the late mother’s final insurance documents, and there was nothing to show it had changed hands. The family had to pay £4,000 in tax on the ring.

Mr Levy says: ‘Items shouldn’t disappear. There is a good chance HMRC will query it, and if they find that you haven’t disclosed it, then everything is up for grabs.

‘From that moment, they will query everything because you have lost your credibility.’

Penalties for not paying up

Last week, the interest charged on unpaid inheritance tax rose to 6 per cent. It’s the eighth time it has increased from 2.75 per cent a year ago.

A penalty can then be added to the interest charge, depending on the reason for underpayment. Where a mistake has been made, or there was lack of reasonable care, families could pay up to 30 per cent of the extra tax due.

Deliberate underpayment adds between 20 per cent and 70 per cent, while deliberate action coupled with concealment can add up to 100 per cent of the extra tax due.

For example, where a £10,000 item — which has been mistakenly left off accounts and should have been taxed at 40 per cent — is discovered 12 months later and the family is given a 10 per cent penalty, they will owe £4,664. 

This includes the initial tax of £4,000, plus a 10 per cent (£400) penalty and £264 interest.

So it’s important to pay the right amount first time, and then pay up as soon as possible if you have underpaid.

Families paid a record £6.1 billion in death duties last year, up £729 million on the previous 12 months. Rising property prices are partly to blame.

Sean McCann, of NFU Mutual, warns families can face investigation if they undervalue a home.

‘All HMRC needs to do is go on an online site such as Rightmove and see how much similar properties have sold for,’ he says.