Inheritance tax (IHT) is currently under HM Revenue & Customs’ (HMRC’s) spotlight and it is reviewing the various exemptions and reliefs available. Research indicates that fewer than half of individuals making gifts are aware of IHT rules and exemptions. For those wishing to mitigate their exposure to IHT and preserve their wealth for future generations, an understanding of the IHT rules and reliefs for gifts is invaluable.
IHT is chargeable at 40% on the value of the death estate above the current nil rate band (NRB) of £325,000. An additional NRB of £150,000 (increasing to £175,000 from 6 April 2020) can be available if a main home forms part of the estate and is bequeathed to children or grandchildren.
Transfers between spouses or civil partners are usually exempt from IHT. If one partner does not fully utilise their NRB, this can be added to that of the survivor, which can result in a total NRB (including the supplementary NRB for the main home) of £950,000 (increasing to £1 million from 6 April 2020).
Business Property Relief and Agricultural Property Relief can give 100% relief on certain assets. These reliefs are complicated, so professional advice is recommended.
The seven-year rule
Lifetime gifts are generally disregarded for IHT purposes if the donor survives seven years from the date of gift. However, the gift of an asset will be ineffective for IHT purposes if an individual continues to benefit from it. The definition of ‘benefit’ is widely drawn for these purposes. For example, giving away your house and continuing to live there rent-free, or buying your child a car and using it for your own journeys are situations which could be caught.
There are some lifetime gifts which are not considered when calculating the estate’s value, even if made in the seven years prior to death. For example, there is an exemption for gifts totalling up to £3,000 in each tax year. Any unused annual exemption can be carried forward, but only for one tax year. Hence, a couple could potentially give away £12,000 between them in a single tax year, if no gifts were made in the preceding year.
Individuals can generally make unlimited small gifts (of up to £250 per person) during the tax year, in addition to their annual exemption of £3,000.Gifts of £5,000, £2,500 or £1,000 given, respectively, to a child, grandchild or other individual on marriage will also be exempt from IHT.
Gifts made regularly out of surplus income (ie net income not required to meet an individual’s annual living expenses) will be exempt from IHT, provided various conditions are met. If approved by HMRC, this can be a very generous exemption with no monetary limits, yet it tends to be underused. Whilst it does not reduce the capital value of the estate, it can help freeze any further growth.
Various other gifts also qualify for exemptions. These include gifts to charity, a political party or, in narrow circumstances, gifts to fund the living costs of dependent relatives.
We would recommend that readers keep the various IHT rules and exemptions in mind when making gifts, to ensure that they do not make any costly mistakes. Equally, early IHT planning – especially large lifetime gifts – can significantly reduce IHT exposure. Therefore, it makes sense to maximise the available exemptions as part of your wider IHT planning.
Assistant Manager, Personal Tax