Inheritance Tax Free Gifts
Background
In last weeks Muras Matters we set out how a Will can be varied in order to mitigate Inheritance Tax (IHT) charges on an estate, however there are various exemptions and some simple planning opportunities which can be used before an individual passes away.
PET’s
Making large cash gifts to reduce the value of an estate is known as making a Potentially Exempt Transfer (PET). IHT is not charged on a PET unless the donor making the gift passes away within 7 years of the transfer. If the donor does pass away within 7 years, then the gift is known as a ‘failed PET’ and, depending on factors such as the size of an estate, IHT may become chargeable as a result of a failed PET.
The 7 year rule introduces a large amount of uncertainty over estates, potentially for a long period of time. When the liability finally becomes apparent there is no guarantee that the funds will be available to pay it.
Exemptions
There are a number of exemptions where gifts are free from Inheritance Tax, either immediately or when the donor passes away. The main exemptions are as follows:
1. Annual exemption – every individual has an annual exemption of £3,000 per year which can be given away with no IHT implications. Any amount unused can be carried forward to the next tax year only, therefore up to £6,000 could be given away.
2. Small Gifts Exemption – up to £250 per recipient per tax year can be given away. This exemption cannot be used to cover part of a larger gift, but the annual exemption could. If £500 is given to one recipient then it can be covered by the annual exemption but not the small gifts exemption. If the annual exemption has already been used then the whole amount is a PET and potentially IHT could be due in future.
3. Wedding presents – parents can give away up to £5,000, grandparents up to £2,500 and anyone else up to £1,000 on the marriage of the recipient.
4. Spouse exemption – transfers to your spouse are usually free from IHT, subject to specific rules over domicile.
5. Normal expenditure out of income – where the gift is made from net income which the donor does not require for living expenses, subject to conditions, the gift is exempt from IHT. The gift must form part of the normal expenditure of the donor, meaning the gift be part of a regular pattern. Potentially this is a generous exemption but proving gifts meet these requirements can be onerous.
Practical Tip
A deceased person’s executors must list the gifts in the last 7 years of the donor’s life and prove that the exemption applies in some detail. The donor must also avoid deriving any benefit from the gift afterward, in order for the gift to be effective.
Proving the exemption applies, potentially years after making the gift, can be difficult. If you are considering IHT planning, we strongly advise first taking professional advice.
If you have any concerns over making gifts from your income or Inheritance Tax in general please contact our Tax Director, Jenny Marks.