IHTM26122 - Step 4 - grossing up: how grossing up works

The function and importance of grossing up (IHTM26121) is illustrated by the following simple example.

Tyrone died on 1 July 2001 with an estate valued at 拢600,000. By Will (IHTM12041) he left:

There is no business relief or agricultural relief so interaction (IHTM26003) is not involved. Tyrone has not made any lifetime transfers.

The residue is exempt. The only taxable gift is that to the daughter. The problem is how to quantify it.

If the legacy had not been free of tax, there would be no problem. Tax could have been charged on the nominal amount of the legacy - 拢367,000. The tax would have been 拢50,000 and the daughter would have received a net sum of 拢317,000. The spouse would have received a residue of 拢233,000.

But as the daughter鈥檚 legacy is free of tax, she will receive the full 拢367,000 despite the tax payable on it. The tax comes out of the residue, reducing the net benefit to the spouse to well under 拢200,000. So it would be unsatisfactory to limit the tax liability to 拢50,000. Instead the rules require the daughter鈥檚 legacy to be grossed up to an amount that reflects the nominal value of the legacy plus the benefit she gets from not paying tax.

Effectively you are working out how much the legacy would have to be so that, once you deduct the tax payable on that 鈥榞ross鈥� amount, the net amount you are left with is the actual amount of the free of tax legacy. Ignoring any nil rate band, a 鈥榞ross鈥� legacy of 拢100 subject to tax at a rate of 40% would leave a net sum of 拢60 (拢100 less 拢40 tax). So to gross up a net sum of 拢60 you have to multiply this by 100 and divide by 60 to calculate the 鈥榞ross鈥� legacy of 拢100. Multiplying by 100 and dividing by 60 is the same as multiplying by five-thirds, which is how this calculation is often expressed.

The grossing up calculation is:

Nominal amount of legacy = 拢367,000

Less nil-rate band -拢242,000

Excess = 拢125,000

Gross up at 40% (or multiply by 100 梅 60) = 拢208,333

Add back the nil-rate band +拢242,000

Grossed up value of legacy = 拢450,333

The exempt residue is 拢600,000 - 拢450,333 = 拢149,667

You can check the result by calculating the tax on 拢450,333 and then deducting it. The difference should be the same as the nominal amount of the legacy. The figures are:

拢450,333 - 拢83,333 = 拢367,000