Income vs Inheritance tax on credited vs accrued savings interest

DemeSon

Dad died 1st April 2023.  His estate should be relatively simple to process because we had converted all his assets (house, stocks , premium bonds) to cash over the last 12 months. That cash was  in his  almost zero interest bank account.  Last November because of rising interest rates we opened 2  restricted access banks accounts with a decent  interest rate in his name and transferred 80% of his funds into them.
We know we need to go through probate and I've gathered all the numbers including arrears payments  but I'm struggling to get a clear understanding  on his interest taxation to present the correct IHT numbers.

I'll use round numbers to keep it simple.

He was receiving a basic teachers and DWP pension so he had basic income and is required to pay income tax
The estate is approximately  £2M so he will sadly need to pay inheritance tax at 40%  on >£1M after housing allowances. 
He probably earned about £1500 in interest on his "zero" account in 2022/2023 - waiting for the tax certificates
However because of the transfers we made last year he has accrued about £15,000 in interest on the high interest accounts.
To be clear on my definition of accrued -  this is interest earned but not yet added to the savings accounts at his death on 1st April 2023 

My understanding is he will need to pay 2022/23 Income tax on the accrued interest, but not inheritance tax.
We will need to pay income tax on any interest he earns after death until probate is completed and funds transferred to beneficiaries. 
I'm basing that understanding on this
TSEM7262 - Deceased persons: interest received - HMRC internal manual - GOV.UK (www.gov.uk)

Is this understanding correct?
I've asked the Inland Revenue to clarify  but they are so busy at the moment you speak to someone who sounds like a temp working through a checklist. Says we must complete a return because we have over £10K of interest, but doesn't seem to understand the specific question.  

Keep_pedalling

If interest is paid out after death then it will not be subject to IHT but his estate will need to pay IT on the full amount as estates don’t get an allowance. 

DemeSon

Pretty sure that  I was wrong.   Apparently I was looking at the wrong page.

https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm10071

IHTM10071 - Bank and building society accounts : investigating alues

The value returned should include the amount in each bank account at the date of death and any interest that was due, but not paid or credited to the account, up to the date of death. The bank or building society will be able to give taxpayers this information.

I will be very happy to be proved wrong on this if you have a source.

What i can't grasp at the moment is that number at death  will be gross interest which will be taxed at 40% for Inheritance.

We will then need to pay income tax of 20% on that untaxed gross interest at some future point meaning we're paying inheritance tax on income tax. Surely the Inheritance tax should be on net, not gross? 

Keep_pedalling

Surely interest paid annually is not due until the anniversary of the deposit?

https://www.gov.uk/hmrc-internal-manuals/trusts-settlements-and-estates-manual/tsem7262

poppystar

But surely if the account had been closed on date of death (or deemed to be ended by that death) then the accrued interest would be paid at that point even if it was an annual interest account? A statement from the savings provider should give the value at that date then any subsequent interest if the account is not actually closed goes to the estate.

The interest to death would be reported to HMRC and an adjustment would be made to assess any under or over payment of income tax for that tax year.

Keep_pedalling

poppystar said:

But surely if the account had been closed on date of death (or deemed to be ended by that death) then the accrued interest would be paid at that point even if it was an annual interest account? A statement from the savings provider should give the value at that date then any subsequent interest if the account is not actually closed goes to the estate.

The interest to death would be reported to HMRC and an adjustment would be made to assess any under or over payment of income tax for that tax year.

Accounts may be frozen once someone has died but they are not usually closed at that point. Any accounts bringing in this amount of interest won’t be closed until probate has been obtained. An account holder cannot close a fixed term account until it matures, at least not without penalties. 

Most institutions will allow fixed term accounts to run to maturity after the death of the holder but give the executor the choice of closing it early, either way interest will be due and payable after death, so will be subject to IT (unless it was in an ISA) not IHT.

DemeSon

The interest on these accounts is payable on the anniversary (Nov 2023)  or closure on death. As keep_pedalling points out because probate is required they are frozen for withdrawals but all other terms stay the same until probate is completed.

The 3rd party professional advice we've received is that Inheritance Tax is payable on accrued interest as i've described it  - the Tsem7262  mentioned above refers to income tax and we should be using IHTM10071 for guidance.  

Tried the Inland Revenue again today. After being put on eternal hold once  and dropped  twice for an hour , the answer I got was:- include the accrued interest on the IHT 406, put a note on the IHT 406  and someone will look at it.  

I'm still not wholly convinced because of the word "due" (it wasnt) on IHTM10071   but without access to a decison maker I'm going round in circles. It feels like this is not a unique situation and the rules on this should be very clear. But perhaps not having any significant  interest on bank accounts since 2008 has made this a new situation.    

Swiss_Danny67

Came here looking for this. Leeds Building Society gave me a form with accrued interest. Newcastle BS did not. In the end I reported the accrued interest and will also do the estate return on an accruals basis too to avoid the income being taxed twice.

poseidon1

DemeSon said:

The interest on these accounts is payable on the anniversary (Nov 2023)  or closure on death. As keep_pedalling points out because probate is required they are frozen for withdrawals but all other terms stay the same until probate is completed.

The 3rd party professional advice we've received is that Inheritance Tax is payable on accrued interest as i've described it  - the Tsem7262  mentioned above refers to income tax and we should be using IHTM10071 for guidance.  

Tried the Inland Revenue again today. After being put on eternal hold once  and dropped  twice for an hour , the answer I got was:- include the accrued interest on the IHT 406, put a note on the IHT 406  and someone will look at it.  

I'm still not wholly convinced because of the word "due" (it wasnt) on IHTM10071   but without access to a decison maker I'm going round in circles. It feels like this is not a unique situation and the rules on this should be very clear. But perhaps not having any significant  interest on bank accounts since 2008 has made this a new situation.    

This subject was discussed ( extensively) in the STEP forum per link below.

https://trustsdiscussionforum.co.uk/t/accrued-income-up-to-date-of-death/16415

The third party professional  is clearly correct in stating that accrued income ( not yet paid ) must be included on the iht return with IHT potentially assessable thereon. However by HMRC concession you are permitted to net off the basic rate tax or dividend rate of tax such income would be liable. Not sure if the professional you consulted flagged this point.

Within the forum discussion Malcolm Finney ( a highly renown tax consultant and  author of a multitude of tax text books across multiple sectors ) was a lone dissenting voice with regard to the facility to net off income tax ( he believed there to be no income tax deduction to the gross accrued income figure ). However HMRC's guidance notes  to the completion of form IHT 400 is unambiguous on this point ( at page 70 ).

In passing, I have always considered that the treatment of accrued income for IHT purposes is a particular trap for the unwary, since of necessity it is a form of double taxation which many people would not imagine should arise.

I do wonder how many others attempting the IHT 400 on a DIY basis without the benefit of professional advice, continue to overlook accrued income ( after netting off attributable income tax) for IHT reporting purposes.