Recently, I met with my client, Ian, who wanted to discuss making charitable donations through his will as part of his estate planning. A friend had advised him that donating 10% of his net estate to charity upon his death would result in no cost to his estate.

I explained that this wasn’t entirely correct and that I thought his friend might have misunderstood the rules. However, subject to the right conditions, it is possible for a charitable gift to be made an no cost.

Understanding Inheritance Tax and Charitable Donations

To explore whether Ian could benefit from such an approach, we reviewed the relevant steps.

When a person dies, inheritance tax (IHT) is charged at a flat rate of 40% on the net taxable value of their estate above the nil rate band. However, if certain conditions are met, a lower rate of 36% applies.

Under Schedule 1A of the Inheritance Tax Act 1984, this lower rate can be achieved if at least 10% of the "baseline amount" of the estate is donated to charity. The baseline amount is the net estate, excluding the residence nil rate band and the charitable donation.

Net estate		£2,500,000
Less: available nil rate band	(£325,000)
Baseline amount		£2,175,000

Baseline amount x 10%		£217,500

To meet this charitable giving condition, one could include a provision in their will to donate to charity an amount equal to 10% of the baseline amount as calculated under paragraph 5 of Schedule 1A IHTA 1984.

While a 4% reduction in the inheritance tax rate might not seem substantial, it can significantly reduce the estate's tax liability—potentially by around 20%.

Why Ian's Friend Was Incorrect

Ian’s friend's claim that a charitable donation would come at no cost to the estate is misleading. While HMRC does subsidize a significant portion of the donation for charitable purposes, the estate still bears some cost—often about 25%. For example, a £217,500 charitable donation could effectively cost the estate only £54,000 after tax relief.

In some scenarios, a charitable gift can be made at no net cost or even result in a financial gain—a concept I explained to Ian.

A Unique Estate Planning Strategy: Section 143 IHTA 1984

Section 143 of the Inheritance Tax Act 1984 provides a unique opportunity to make a charitable donation in a way that could save both inheritance and income taxes. Here’s how it works: The testator (person who makes the will) leaves a gift to a beneficiary with an expressed wish that the beneficiary donate that gift to charity within two years of the testator's death.

This approach hinges on the beneficiary's willingness to comply since they are not legally obligated to make the donation. If the beneficiary does comply, the donation is treated as if the testator made it directly. This allows for a recalculation of the IHT and a potential refund, while also granting the beneficiary the ability to claim income tax relief on the donation.

The gift is treated as being made by the beneficiary for income tax purposes, allowing them to claim Gift Aid. This grossed-up amount is added to their basic rate band, which can lead to a significant income tax reduction if the beneficiary is a higher-rate or additional-rate taxpayer.

Applying This Strategy to Ian's Situation

Ian is separated from his wife and has one daughter, who is employed in a senior role earning approximately £300,000 per year. They are close, and Ian believes she would honour his wishes to donate a portion of his estate to charity, even if there were no direct benefit to her.

Ian's net estate, after applying the nil rate band, is £2,175,000, resulting in an inheritance tax liability of £870,000.

Gross estate		£2,500,000
Less: available nil rate band	(£325,000)
Taxable estate		£2,175,000

Inheritance tax @ 40%		£870,000

By making a charitable donation of £217,500 (10% of the baseline amount), the estate would qualify for the reduced IHT rate of 36%, lowering the liability to £704,700. This results in a tax saving of £165,300, bringing the net cost of the donation to £52,200.

Gross estate		£2,500,000
Less:
Charitable donation	(£217,500)
Available nil rate band	(£325,000)
Taxable estate		£1,957,500

Inheritance tax @ 36%		£704,700

However, if Ian's daughter makes the donation on his behalf, she can claim Gift Aid, increasing the donation to £271,875 (£217,500 is treated as 80% of the full amount).

This would reinstate her personal allowance, extend her basic rate tax band to £309,575 and reduce her income tax liability from £121,203 to £57,486, resulting in an income tax refund of £63,717.

Without Gift Aid claim

Salary		£300,000
Less: personal allowance (abated)	(£0)
Taxable Income		£300,000

Tax
£37,700 @ 20%	£7,540
£87,440 @ 40%	£34,976
£174,860 @ 45%	£78.687
Total tax liability		£121,203

With Gift Aid claim

Salary		£300,000
Less: personal allowance (reinstated)	(£12,570)
Taxable Income		£287,430

Tax
£12,570@ 0%	£0
£287,430 @ 20%	£57,486
Total tax liability		£57,486
Less: tax deducted at source under PAYE	(£121,203)
Income tax repayment due		£63,717

When combined with the inheritance tax savings, the total tax benefit would be £229,017—£11,517 more than the amount donated.

Key Benefits of This Approach

By making a charitable gift under Section 143 IHTA 1984, Ian could achieve three key benefits:

The estate makes a substantial charitable gift at no net cost.
Ian’s daughter receives an additional benefit of £11,517 to her estate.
The charity receives 20% more than if the gift had been made directly through the will, due to the Gift Aid claim.

Conclusion

This strategy demonstrates the potential for significant benefits for both the beneficiary and the charity when a gift is made indirectly via a beneficiary. However, it’s crucial that the beneficiary's income tax liability is sufficient to cover the Gift Aid claim, or they could face an unexpected liability to make up the Gift Aid claim amount.

A philanthropic society fosters a culture of giving, caring and mutual support, creating an environment where economic capital is continually reinvested for the benefit of all. If you want to make sure your charitable contribution results in the maximum benefit for both your estate and your chosen charity, we can discuss this as part of your estate planning.

Please note that the information contained in this blog post is provided for general informational purposes only. It does not constitute any form of legal or tax advice, and you should not use it as a substitute for advice tailored for your specific circumstances. I disclaim all and any liability for any actions you take (or omit to take) in reliance upon the contents of this post.

Charitable Donations in a Will: The Zero-Cost Donation