Inheritance tax investigations surge 41% as more families face scrutiny

Families are enduring a surge in inheritance tax (IHT) investigations as more are suspected of trying to avoid the 40 per cent charge.

The number of investigations opened by HM Revenue & Customs in the 2024-25 tax year reached a record high of nearly 4,000 — a 41 per cent increase on the previous year, when there were 2,807.

HMRC begins an investigation if it suspects IHT could have been underpaid, either through error or a deliberate attempt to undervalue the assets in a person’s estate. The taxman can use wide-ranging powers to gather evidence from various sources to understand the dead person’s financial situation.

Sean McCann from the wealth manager NFU Mutual, which used a freedom of information request to get the HMRC data, said: “This can include analysing bank statements to identify income, which may suggest the existence of undisclosed assets such as investments or property, or significant foreign currency transactions.”

IHT investigations can often take months or even years to complete. They examine gifts made in the seven years before death (those made earlier are not counted as part of the estate for inheritance tax purposes), life insurance premiums and overseas assets — areas where families often make innocent mistakes when declaring assets.

In one case that reached a tax tribunal in 2015, two brothers believed that valuable paintings had been given to them many years before their parents’ death, so should be excluded from IHT. But because the paintings had never left the family home, the parents were deemed to have continued to benefit from the gift — by displaying them — and HMRC ruled they were still part of the taxable estate. Such gifts are classed as “gifts with reservation of benefit” and remain subject to inheritance tax even if their ownership has technically changed.

A common trap involves parents transferring ownership of their home to their children but continuing to live in it rent-free, which also counts as a gift with reservation of benefit. To remove a property from an estate for IHT purposes (providing it also passes the seven-year rule), the original owner must either move out or pay full rent— something many families overlook.

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McCann said: “The interest rate you pay on overdue inheritance tax is 8.25 per cent a year, which can add a significant amount to the bill. This can compound what for many is already a challenging and distressing situation.”

It comes as more families are being forced to pay inheritance tax. A key driver behind the increase is the freezing of IHT-free thresholds — the £325,000 nil-rate band has remained unchanged since 2009, and the additional £175,000 residence nil-rate band (for those leaving a main home to direct descendants, unless their estate is worth £2 million, above which this allowance starts to reduce) has been frozen since 2020. Anything above these allowances is taxed at 40 per cent.

The thresholds will remain frozen until 2030, pulling more estates into taxable territory each year as asset values grow.

HMRC last week revealed that 31,500 estates paid inheritance tax in 2022-23 — a 13 per cent rise on the year before.

McCann said: “The revenue recovered through these investigations is significant, and the rising value of assets and the potential sums at stake would appear to justify HMRC’s time.”

Rachael Griffin from the wealth manager Quilter said: “Frozen thresholds mean more families are unexpectedly caught by inheritance tax. With HMRC using more advanced data and technology, investigations are becoming more frequent — even for those who never thought they would be affected.”

Despite IHT being one of the most feared taxes, McCann says it remains “the least understood”. While awareness is improving, many families still overlook legal ways to reduce their liabilities, such as giving away money in their lifetime, setting up trusts or keeping records of assets and exemptions.

Changes to pension rules from April 2027 could alter how families pass on wealth. From that point, pensions will form part of the taxable estate — meaning more people will exceed their IHT allowances and even begin to lose their residence nil-rate allowance if pension wealth tips their estate’s value above £2 million. The £175,000 allowance is cut by £1 for every £2 that the estate is worth above this threshold.

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However, anything left to a spouse or civil partner, including pensions from 2027, is exempt from inheritance tax. Couples can also combine their allowances to pass on a total of £1 million IHT-free, providing they don’t lose their residence nil-rate allowance.

“Many people planned to leave their pension untouched as it can be passed on IHT-free — but with that changing soon it’s likely we’ll see an increase in withdrawals as people seek to make gifts or invest in IHT-mitigation products,” McCann said.

His advice to families is simple: keep clear records of gifts, valuations and overseas assets, and use HMRC forms such as the IHT403 to track lifetime gifting. He added: “Getting it right the first time reduces the chances of any penalties or interest payments.”

HMRC said: “The vast majority of people pay the correct inheritance tax. Investigations are only opened into cases where there’s evidence the right amount of tax has not been paid.”