When you make a gift of cash or other assets, either during your lifetime or through your will after your death, there are certain exemptions from IHT available.
Exemptions: Lifetime or on death
Gifts to the following recipients are completely exempt from IHT, irrespective of whether such gifts are made during a person’s lifetime or on their death:
- spouses or civil partners although the spouse exemption could be limited if the transferee is domiciled outside the UK;
- UK charities;
- certain specified bodies for national purposes; and
- UK political parties (subject to certain conditions being met).
The exemptions which only apply to gifts made during lifetime are:
- The annual exemption. You can gift up to £3,000 every year, free from IHT. If you do not use your exemption in one tax year, you can bring it forward to the next tax year so that a potential £6,000 allowance is available in the following tax year.
- The small gifts exemption. This applies to gifts of up to £250 for each recipient and which are not within the scope of any other exemption.
- Gifts made in contemplation of marriage or civil partnership. The following gifts to the parties to the marriage or civil partnership are exempt:
- A gift of up to £5,000 made by each parent of the parties to the marriage or civil partnership;
- A gift of up to £2,500 made by the grandparents or remoter ancestors;
- A gift of up to £1,000 made by any person; and
- A gift of up to £2,500 made by one party to the marriage to another.
- Normal expenditure out of income exemption. You can make gifts out of your income, providing you have sufficient to maintain your usual standard of living after the date of the gift. These gifts must be made on a regular basis and a pattern of payments must be able to be demonstrated.
- Maintenance. Although not strictly an exemption, gifts made for the maintenance of family members (i.e. spouse/civil partner, minor children, children in full time education and relatives financially dependent on the person making the gift) are not treated as transfers for IHT purposes so no liability will arise.
Potentially exempt transfers (“PETs”)
Where a person makes a gift to an individual and survives seven years from the date of the gift it will not be chargeable to IHT. If the person dies before 7 years, the value of the gift will form part of that person’s estate for IHT purposes and will be set against their available nil rate band. For the current tax year, this is £325,000.
Taper relief can apply to a gift but only where tax is due because on death within 7 years it exceeds the available nil rate band. If the person making the gift fails to survive at least 3 years after the date of the gift, no taper relief will be available. From that point the relief operates to reduce the tax payable on the gift on a sliding scale for every extra year the person making the gift survives. If the person survives 3-4 years, 4-5 years, 5-6 years, 6-7 years or 7 years and over, the rate of taper relief is 20%, 40%, 60%, 80% and 100% respectively.
For example, if Alfie makes a gift of £400,000 to his son Bill on 1 April 2013 and Alfie dies on 5 March 2017, IHT will be payable on the gift because he has failed to survive 7 years from the date of the gift and the gift exceeds Alfie’s nil rate band. After deducting two annual exemptions (£6,000) and the available nil rate band (£325,000), the chargeable value of the gift is £69,000. The IHT payable is £27,600 (40%). Taper relief at 20% can be deducted, as Alfie survived 3-4 years from the date of the gift, resulting in the total IHT due on the gift amounting to £22,080.
As shown above, taper relief is applied to the IHT due on the gift, not the value of the gift. If the value of the gift is within the available nil rate band so no tax is due, there is no taper relief available.
It is particularly important to note that in order for a PET to fall outside of a person’s estate for tax purposes after 7 years, the person making the gift must not retain any benefit for themselves. For example, if a person gives their home to their adult children (who live elsewhere) and continues to live there rent free, this would be a gift with reservation of benefit and would be chargeable to IHT as though the gift remained within the person’s estate.