The Inheritance Tax Implications of Gifts
Research carried out by the National Centre for Social Research (NCSR) and the Institute for Fiscal Studies (IFS) recently found that there is a ‘staggering lack of awareness’ of the inheritance tax (IHT) implications of making a financial gift. Below we outline the gifting rules and the IHT implications.
Annual £3,000 exemption
Every year, an individual may give gifts of up to £3,000 without being charged any IHT. Any unused amount may be carried forward for one year only.
Other exemptions include giving as many gifts as you want of up to £250 per person per tax year. Gifts between spouses/civil partners are exempt from IHT, and on death, a spouse can pass on their unused Nil-Rate Band (currently at £325,000 each).
Wedding gifts of up to £5,000 made to children are exempt from IHT; gifts of up to £2,500 to grandchildren or great-grandchildren are exempt; and up to £1,000 is exempt if the gift is given to any other relative or friend. Gifts to registered charities are also exempt, as well as those to political parties, under certain conditions.
Gifts given to help with family maintenance are also exempt from IHT. These can be in the form of a transfer of property on divorce; gifts to children aged under 18 or in full-time education; or gifts towards the living costs of a dependent.
Normal expenditure out of income is outside the scope of IHT. If the individual can give away some of their income without it adversely affecting their standard of living, then any such amount falls outside IHT. If standard of living is affected, such gifts would be deemed as capital as thus reliant on the above rules.
Potentially Exempt Transfers
Potentially Exempt Transfers (PETs) are, as the name says, transfers or gifts that may potentially be exempt depending on when the gift was given. In this case, a person may choose to give a gift up to the IHT threshold without incurring any IHT. You may, however, need to take into consideration other taxes, such as capital gains tax.
If the donor dies within seven years of making the large gift, then IHT will be due. The amount of IHT due will be dependent on the number of years that have passed since giving the gift and the donor’s death.
Gifts made within three to seven years before a donor’s death are taxed on a sliding scale known as ‘taper relief’. This means the effective IHT rate for three to four years between gifting and death is 32%; for four to five years it’s 24%; for five to six years it is 16%; and between six and seven years it will be 8%. After seven years, no IHT will be due on the gift.
The IHT threshold
The IHT threshold (or Nil-Rate Band) for an individual is £325,000, and potentially £650,000 for married couples/civil partners upon the second death. An additional Residence Nil-Rate Band (RNRB) is available for estates which include residential properties. Any unused RNRB can be transferred between spouses upon the first death. From 6 April 2019, the RNRB is £150,000, rising to £175,000 from 6 April 2020, and is available when the residential property is bequeathed to a direct descendent.
There may be scope for substantial savings when planning your estate by giving gifts, so please do get in touch.
Please note: This article is a commentary on general principles and should not be interpreted as advice for your specific situation.