How Grossing Up Inheritance Tax Works: The 20/80 Formula and Examples

Grossing up inheritance tax is the adjustment you make when the donor of a chargeable lifetime transfer agrees to pay the tax personally instead of leaving the trustees or recipient to settle it. Because inheritance tax is charged on the total loss to the donor’s estate, the tax payment itself counts as part of the transfer, so you have to solve for a gross figure where 20% is tax and 80% is the net gift. On the slice above the available nil rate band, that pushes the effective rate from 20% to 25%.

Why the Tax Itself Becomes Taxable

Inheritance tax measures the drop in the donor’s net worth caused by a disposition, not the sum the recipient receives.¹ If the trustees pay the tax out of the settled funds, the only money leaving the donor is the gift. If the donor writes a cheque for the tax on top, the estate loses the gift and the tax combined, and HMRC taxes that combined figure.

That is where the circularity comes from. You cannot simply apply 20% to the net gift, because the tax you calculate then increases the loss to the estate, which increases the tax again. The grossing-up formula finds the gross figure where the arithmetic settles: 80% of it is the net gift, 20% of it is the tax.²

When Grossing Up Applies

Grossing up only matters for chargeable lifetime transfers where the donor bears the tax. In practice that almost always means gifts into discretionary trusts and similar arrangements that carry an immediate inheritance tax charge. HMRC’s manual is explicit that grossing up does not apply to failed potentially exempt transfers, and it does not apply where the trustees or recipient pay the tax from the gifted funds.²

Outright gifts to individuals are potentially exempt transfers. No immediate tax arises, and if the donor survives seven years they fall out of the inheritance tax net entirely, so grossing up never comes into play.³ The pivotal question when funds go into a trust is who is paying the tax. Trust pays, standard 20% on the excess above the nil rate band. Donor pays, gross up.

Working Out the Chargeable Amount

Strip out exemptions before you calculate anything. The annual exemption is £3,000 per tax year, and an unused prior year carries forward one year, so up to £6,000 can be sheltered in a single year. Small gifts of up to £250 per recipient are also exempt where no other exemption has been used on the same person.⁴ Spouse and civil partner transfers, charitable gifts, and gifts in consideration of marriage also come off the top.

Then look at the nil rate band. It sits at £325,000 and is legislated to stay there until at least April 2030.⁵ You do not get the whole band for each transfer. HMRC cumulates every chargeable transfer made in the seven years before the current gift, and only the unused portion shelters the new one. If you settled £200,000 three years ago, only £125,000 of the band is left today. Pulling together that seven-year history is the preparatory step that most often gets skipped, and missing an earlier transfer leads to under-reported tax.³

The 20/80 Formula

The lifetime inheritance tax rate is half the death rate, so 20%.⁶ Where the donor pays the tax, the tax on the portion above the available nil rate band is:

Tax = net chargeable amount × 20/80

The fraction (20/80, or one quarter) reflects the split inside the gross figure: 80% is the net gift, 20% is the tax. Every £80 the recipient gets above the threshold costs the donor £20 of tax, a total loss of £100, and 20% of £100 is £20. The donor’s economic outcome is a 25% charge on the amount given above the threshold.⁷

Example One: Whole Gift Above the Nil Rate Band

The donor has already used their full nil rate band on earlier chargeable transfers. They now settle £100,000 into a discretionary trust and pay the tax themselves.

Net chargeable amount: £100,000
Tax: £100,000 × 20/80 = £25,000
Gross transfer (total loss to estate): £125,000
Check: 20% × £125,000 = £25,000

Example Two: Gift Straddling the Nil Rate Band

The donor has made £200,000 of chargeable transfers in the previous seven years, leaving £125,000 of the nil rate band available. They settle £200,000 into a trust and pay the tax personally.

Sheltered by remaining band: £125,000 (no tax)
Net chargeable amount above the band: £75,000
Tax: £75,000 × 20/80 = £18,750
Gross transfer: £200,000 + £18,750 = £218,750
Check: 20% × £93,750 (grossed-up excess) = £18,750

The 20/80 fraction applies only to the slice above the available nil rate band. Anything sitting inside the band carries no tax and does not need grossing up.

If the Donor Dies Within Seven Years

A chargeable lifetime transfer is revisited if the donor dies within seven years. It is recalculated at the full 40% death rate, with credit for the lifetime tax already paid, so the estate pays only the difference. If the recalculated figure comes out lower than what was paid at lifetime rates, HMRC does not refund the excess.⁶

Taper relief reduces the death-rate charge where the donor survived at least three years:

3 to 4 years before death: 80% of the full death rate
4 to 5 years: 60%
5 to 6 years: 40%
6 to 7 years: 20%

Taper reduces the rate, not the value of the gift. A transfer made four and a half years before death would be charged at 60% of 40%, or 24%. If that exceeds the lifetime tax already paid, the estate covers the shortfall. Keep records of every chargeable transfer and every tax payment, because the seven-year recalculation depends on them.

Reporting and Paying

A chargeable lifetime transfer with a tax liability is reported on Form IHT100, and the tax is due six months after the chargeable event.⁸ You need an inheritance tax reference number before you can pay. Apply on Form IHT122 at least three weeks ahead, because HMRC needs time to issue it.⁹

Getting the grossing-up figures right before you file saves the correction correspondence later. The framework is the same each time: work out the available nil rate band after seven-year cumulation, identify the slice of the gift that sits above it, and apply the 20/80 fraction to that slice alone.

1
Legislation.gov.uk. Inheritance Tax Act 1984 – Part I, Main Charges and Definitions
2
HM Revenue & Customs. Inheritance Tax Manual – IHTM14593, Lifetime Transfers: Grossing Up the Values
3
GOV.UK. Work Out Inheritance Tax Due on Gifts
4
GOV.UK. How Inheritance Tax Works: Thresholds, Rules and Allowances
5
HM Revenue & Customs. Inheritance Tax Thresholds and Interest Rates
6
Legislation.gov.uk. Inheritance Tax Act 1984 – Section 7, Rates
7
HM Revenue & Customs. Inheritance Tax Manual – IHTM14012, Lifetime Transfers: Burden of Tax
8
HM Revenue & Customs. Tell HMRC That Inheritance Tax Is Due on a Gift or Trust (IHT100)
9
GOV.UK. Apply for an Inheritance Tax Reference After a Chargeable Event (IHT122)