HMRC have recently reported that more than a quarter of UK residents have made a gift of £1,000 or more in their lifetime so far. The research has indicated ‘a general lack of knowledge around inheritance tax (IHT) rules by those gifting.’ What can you gift and what are the tax implications of doing so?
Gifts made by individuals may qualify for specific exemptions for IHT purposes and as such are tax efficient ways of giving away assets and organising your estate in a tax efficient way through ‘asset reduction’. There are a number of important exemptions which allow an individual to reduce their estate without giving rise to an immediate charge to IHT:
Potentially Exempt Transfers (‘PET’)
We are a nation of PET lovers. A PET is a gift made from one individual to another. They are potentially exempt and become entirely exempt provided the donor survives seven years after making the gift. This is commonly referred to as the “seven year rule”. There is no limit on the size and number of potentially exempt gifts – they can be for a few thousand pounds or several millions. This makes PETs very attractive for IHT purposes. If death occurs within seven years, the value of the gift is brought back into the estate for IHT purposes. There are also rules about who pays any IHT when death occurs with seven years. There is also an oft-misunderstood ‘taper relief’ that applies to the tax on PETs when death happens within the seven year period.
The one everyone has probably heard of. Gifts up to a total of £3,000 per annum. If the preceding year’s annual exemption has not been used, it can be rolled forward to the current year, but only if the current year’s annual exemption has been used.
Small gifts exemption
A little bit of an IHT saving can come in small packages. Gifts in a tax year of up to £250 to any number of individuals. This cannot be combined with the annual exemption.
Normal expenditure out of income
The gift that can keep on giving. This is a really powerful and often overlooked way of gifting in a very tax efficient way. The size of the gifts are unlimited and there is no need to survive seven year or indeed any period of time at all. Regular gifts out of an individual’s surplus income can be exempt from IHT but there are a number of conditions. This can be a very useful exemption for gifting money to trust where there might otherwise be restrictions on the amounts transferred to the trust.
Gifts in consideration of marriage
Bruno Mars would approve. Gifts made to a person in contemplation of marriage can be exempt (up to a certain value). A parent can gift £5,000 each and a grandparent can gift £2,500. For all others the exemption extends to £1,000.
Gifts for maintenance of a dependant
Again, an exemption that is overlooked. This exemption extends to lifetime gifts for the maintenance of a spouse/civil partner/former spouse/civil partner, a dependent child under the age of 18 (or over 18 if in full time education) or reasonable care or maintenance of a dependent relative who is unable to maintain him/herself due to disability or infirmity are exempt. Being unaware of this exemption during life is not fatal to taking advantage of the exemption. It might be the case that following a death, a review of gifting supports this exemption then being reported to HMRC to minimise IHT on the estate. As with the normal expenditure rule, this exemption can be useful in funding a trust, in this case for a dependant.
Transfers between spouses/civil partners
Gifts between spouses and civil partners are exempt from IHT. However, there are restrictions when gifting to a non-UK domiciled spouse.
Gifts to charities
Gifts to UK registered charities are exempt from IHT.
But, before you get out your chequebook…There are a number of important points to consider when considering lifetime gifting – such as affordability, exposure of assets and capital gains tax. If you wish to make a gift but maintain an element of control and asset protection, making a gift to a trust can be a blend making an effective gift for IHT while creating a protective environment in which to house the assets.