As Inheritance Tax (IHT) is calculated on the value of the estate at death (the assets that you leave when you die), reducing the value of the estate through gifts is the most basic form of IHT planning. We will consider some of the main ones.
There are many gifts that are exempt from IHT, some of the more common ones are:
- Small gifts to any person in a tax year not exceeding £250;
- Gifts in consideration of marriage; £5,000 if made by a parent of one of the couple; £2,500 by a grandparent and £1000 by anyone else;
- Gifts that are part of your normal expenditure out of income and which don’t reduce your net income below that required to maintain your normal standard of living;
- Annual transfers up to £3,000. Any unused amount may also be carried forward for one year only;
- Gifts to charities and registered community amateur sports clubs;
- Gifts to political parties;
- Maintenance payments to ex-partners.
Potentially Exempt Transfers (PETS)
Most transfers to individuals are PETS and so are only subject to IHT if you die within 7 years of making the gift. Even at that stage IHT is only payable if the value of the transfer is over the IHT threshold when it is added to the estate at death plus other lifetime transfers made in the previous 7 years.
So giving your assets away and hoping to live 7 years is the most basic form of IHT planning, although it does of course mean you have lost control of your assets. There is no need to report the gifts when made, but the recipient of the gift should do so within a year of the donor’s death. Care should be taken as there may be other taxes payable, such as Capital Gains Tax on making the gift depending on the type of asset.
The amount of IHT due on the gift is tapered away for gifts made between 3 and 7 years before death.
Gifts made to most trusts and companies are chargeable transfers. These can produce an IHT charge at the time the gift is made at the rate of 20%, if the total cumulative value of these transfers exceeds the IHT threshold.
Gifts with Reservation
Giving away an asset such as your home does not automatically exempt you from inheritance tax should you live 7 years after the gift. While you are still living in the property rent free it is treated as a gift with reservation and the gift is ignored for IHT purposes. However, the gift is recognised for capital gains tax purposes, so you can end up with the worst of both taxes; a property legally in the hands of someone else but treated as yours for IHT while you live there. You can avoid the gift with reservation rules if you pay a market rent for occupying the property.
Not sure of the best course of action?
For further information or advice on any of the above please contact us.