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Gifts and Their Impact on Inheritance Tax in the UK: Navigating the Tax Implications

Published on 
24 Apr 2024

When considering the transfer of wealth to the next generation, inheritance tax (IHT) in the UK is an essential consideration. IHT is a tax on the estate of someone who has died, including all property, possessions, and money. The standard threshold for taxing an estate is £325,000, and anything above this amount could be taxed at 40%. However, there are specific circumstances where this tax could be reduced or even waived, particularly when it concerns gifts made during a person's lifetime.

Gifts are subject to their own set of rules within the realm of inheritance tax. The seven-year rule, for example, means that if an individual makes a gift and survives for more than seven years, the gift is generally exempt from IHT. Moreover, certain gifts are exempt irrespective of the seven-year timeline, such as annual gifts up to £3,000, small gifts of up to £250 per person, and wedding gifts up to a certain limit depending on the relationship to the recipient. Understanding these rules is fundamental for both estate planning and avoiding potential pitfalls.

Key Takeaways

  • The IHT threshold for an individual's estate is set at £325,000, with the excess taxed at 40%.
  • Gifts made more than seven years before death can be exempt from IHT.
  • Specific gifts like small, annual and wedding gifts have immediate exemptions from IHT.

Understanding Inheritance Tax

Inheritance Tax (IHT) in the UK can significantly affect the value of an estate passed on to beneficiaries. This section provides a detailed look at the essentials of IHT, thresholds and rates, and how to calculate the net estate value.

Defining Inheritance Tax (IHT)

Inheritance Tax (IHT) is a levy paid on the estate of someone who has passed away, including all property, money, and possessions. If the total value of the estate exceeds the IHT threshold, tax must be paid at the prevailing rates. This tax can influence how much heirs will inherit and strategies involved in estate planning.

IHT Threshold and Rates

The basic threshold for IHT is £325,000, known as the 'nil-rate band'. Estates valued below this figure do not incur IHT. For estates exceeding this threshold, the standard IHT rate is 40%. However, any amount bequeathed to a spouse, civil partner, charity or community amateur sports club is tax-exempt.

  • Threshold: £325,000
  • Standard IHT Rate: 40%

Net Estate Calculation

The net estate is the total value of all assets after debts and any exempt bequests have been deducted. To determine the net estate, add the value of all the assets, then subtract any debts and the value of tax-exempt bequests. The remaining figure is what IHT is calculated against, provided it is above the IHT threshold.

  • Assets valuation: Include property, money, and possessions.
  • Deductions: Include debts and tax-exempt bequests.
  • Final net estate value: The basis for IHT if above £325,000.

Lifetime Gifts and Exemptions

When planning one's estate in the United Kingdom, understanding the impact of lifetime gifts and their exemptions on Inheritance Tax can result in significant tax savings. Certain types of gifts can be made tax-free, and some may become exempt after a period.

Annual Exemption Limits

Each individual in the UK has an annual exemption limit of £3,000, which allows them to give away this amount each tax year without it being added to the value of their estate for Inheritance Tax purposes. This exemption can be carried forward to the next tax year, giving you a potential total of £6,000 if unused from the previous year.

Potentially Exempt Transfers

Potentially Exempt Transfers (PETs) refer to gifts made during a person's lifetime that are not taxed immediately but can be subject to Inheritance Tax if the donor dies within seven years of making the gift. For gifts between years 3 and 7, tax relief is given on a sliding scale known as taper relief.

Gifts with Reservation of Benefit

A gift with reservation of benefit occurs when an individual gives away an asset but continues to benefit from it, such as living in a property they have given to someone else. These gifts are not exempt from Inheritance Tax; the asset is still considered part of the estate for tax purposes.

Exempt Transfers Between Spouses and Civil Partners

Transfers of assets between spouses and civil partners are generally exempt from Inheritance Tax in the UK. This means that gifts made to a spouse or civil partner during one's lifetime or left to them on death do not incur Inheritance Tax. However, if the spouse or civil partner resides outside the UK, different rules may apply, which can impact the exemption.

Inheritance Tax Reliefs

In the United Kingdom, certain reliefs on Inheritance Tax (IHT) may be applied on estates that include agricultural property, business assets, or gifts made before death. These reliefs can significantly reduce the IHT burden, providing essential benefits to beneficiaries.

Agricultural Property Relief

Agricultural Property Relief (APR) can offer either 50% or 100% relief from IHT on the value of qualifying agricultural property. This property must have been owned and occupied for agricultural purposes for at least two years if directly owned or seven years if owned by a trust or leased out.

  • 100% Relief: Applies to agricultural land or pasture that is occupied for the purposes of agriculture, along with associated cottages, farm buildings, and farmhouses, provided they are of a character appropriate to the holding.
  • 50% Relief: May be granted on certain types of tenanted agricultural property with a shorter occupation period.

Business Property Relief

Business Property Relief (BPR) can reduce the value of a business or its assets when passing on either during the owner's lifetime or as part of the will. Relief is available at rates of 50% or 100%, depending on the type of asset.

  • 100% Relief is available on:
    • A business or interest in a business.
    • Shares in an unlisted company.
  • 50% Relief is available for:
    • Shares controlling more than 50% of the voting rights in a listed company.
    • Land, buildings, or machinery owned by the decedent and used in a business they were a partner in or controlled.

Taper Relief

Taper Relief applies to gifts made between three and seven years before the donor's death. The level of IHT charged on these gifts reduces on a sliding scale, making it less burdensome for beneficiaries as time passes since the gift was given.

  • Reduction Scale:
    • Years 3 to 4: 20% reduction
    • Years 4 to 5: 40% reduction
    • Years 5 to 6: 60% reduction
    • Years 6 to 7: 80% reduction

After seven years, gifts are typically exempt from IHT altogether, providing they fall under certain stipulations regarding the giver’s hold on the asset and subsequent benefits from it.

Impact of Trusts on Inheritance Tax

In the UK, trusts are commonly used vehicles that can alter the timing and amount of inheritance tax payable. Properly structured, they can provide significant tax benefits, contingent upon the trustees' adherence to tax rules and responsibilities.

Trusts and Tax Responsibilities

When assets are transferred into a trust, it may trigger an immediate 20% inheritance tax if the value exceeds the nil-rate band (NRB), currently set at £325,000. Trustees are responsible for managing these assets and must handle the inheritance tax due on trusts. At each ten-year anniversary of the trust's creation, a periodic charge, up to 6%, may be applied on the value of the trust assets above the NRB.

Gifts into a trust can be complex, as the settlor may be liable for the tax if they continue to benefit from the trust, known as a Gift with Reservation. Taxes on these gifts are based on thresholds and rules as specified by Her Majesty's Revenue and Customs (HMRC).

Using Trusts for Tax Planning

Trusts are key strategic tools for tax planning. They can help mitigate inheritance tax if managed correctly. NRB utilisation allows each individual to pass on assets to beneficiaries up to a certain threshold before incurring tax. Trusts can also hold assets that might otherwise increase the inheritance tax burden if they were included in an individual's estate at death.

A popular approach involves making lifetime gifts to a trust. If the settlor survives seven years from the date of the gift, the assets are usually outside the estate for inheritance tax purposes. Utilising a trust in this manner can allow for significant estate tax savings and prove advantageous for long-term inheritance tax planning.

Careful structuring and timing of trusts are imperative to maximise tax planning benefits while complying with HMRC regulations and reporting requirements.

Inheritance Tax and Nontradable Assets

The approach to Inheritance Tax in the UK for nontradable assets, such as property that can't readily be sold on the open market, hinges upon accurate valuation and specific rules for gifts with reservations.

Valuing Property and Estates

For Inheritance Tax purposes, the market value of property is paramount. This is the price an asset might reasonably fetch if sold on the open market at the time of the valuation. The estate's total value includes the market value of nontradable assets such as unique family homes or pieces of fine art. These items may require valuation by a professional to reflect their true worth. If an estate is liable to Inheritance Tax, this tax must be paid on the estate's value above the current threshold of £325,000.

Inheritance Tax on Gifts with Reservation

Gifts with reservation are those that an individual gives away but continues to benefit from, such as a house they continue to live in rent-free. These gifts are included in the value of the deceased's estate for Inheritance Tax calculations. This ensures that individuals cannot simply distribute their estate before death to avoid taxation. The value of these gifts is based on the market value when the reservation ceases, not when the gift was originally given.

It's crucial for those managing an estate or considering their Inheritance Tax planning to understand these nuances to ensure all HM Revenue & Customs (HMRC) regulations are met and any tax liabilities are correctly calculated.

Specific Exemptions and Allowances

The UK's Inheritance Tax system allows for certain exemptions and allowances, which provide opportunities for individuals to pass on assets without triggering a tax liability. Understanding these opportunities can lead to significant tax savings for one's beneficiaries.

Wedding Gifts and Small Gifts

Wedding Gifts: Individuals can give wedding gifts up to a certain value free from Inheritance Tax. For example, they can gift their child, grandchild, or great-grandchild different amounts, with the limit for a child currently set at £5,000. The amount changes depending on the relationship with the person getting married.

Small Gifts: One can also make small gifts up to £250 per person per year without incurring Inheritance Tax. These must be to different individuals and not part of a series of larger gifts.

Normal Expenditure Out of Income

Regular gifts made from one's post-tax income (not capital) that do not affect their standard of living can be exempt from Inheritance Tax. These are considered normal expenditure out of income. The key is that the gifts must be regular, such as a monthly payment to a family member or an annual subscription fee for a friend.

Gifts to Charities and Political Parties

Gifts to charities registered in the UK are exempt from Inheritance Tax. These can reduce the overall value of the estate and potentially lower the tax rate on the remaining estate. Similarly, gifts to political parties that meet certain conditions, such as having at least two members elected to the House of Commons, can also be exempt from Inheritance Tax.

Inheritance Tax Planning Strategies

When considering inheritance tax (IHT) in the UK, strategic estate planning is crucial to mitigate potential tax liabilities. By utilising gifts, allowances, and reliefs, individuals can preserve the value of their estate for future generations.

Gifting and Inheritance Tax Mitigation

One of the cornerstone strategies in inheritance tax planning involves gifting. Individuals are entitled to an annual exemption of £3,000 for gifts, which won't be counted towards the value of their estate. This allowance can be carried forward one year if not used. Furthermore, small gift allowances permit individuals to give away up to £250 per person per year without affecting their inheritance tax.

  • Civil partners and spouses can transfer assets to each other tax-free, both during their lifetime and in a will, which can effectively double the available annual exemption to £6,000 if last year's allowance wasn't utilised.
  • Gifts out of one's income can also be inheritance tax-free, if they do not affect the donor's standard of living.

Maximising Reliefs and Exemptions

Inheritance tax planning often revolves around maximising reliefs and exemptions. Some assets are eligible for relief, possibly reducing the taxable value by up to 100%. Notable reliefs include:

  • Agricultural relief: Certain agricultural property can receive either a 50% or a 100% inheritance tax exemption, which can be a significant advantage for those who own farms or agricultural land.
  • Business relief: This allows some assets passed on as part of a business to be exempt from IHT, or the tax due on them to be reduced by either 50% or 100%, including businesses and shares in certain companies.

Estate Planning with Solicitors and Advisors

Engaging with skilled solicitors and advisors is a critical step for thorough estate planning. These professionals can aid in crafting wills that effectively manage how your estate is distributed, taking into account the intricacies of IHT.

  • Wills and Probate: A solicitor can guide individuals through the process of wills and probate, ensuring all legal formalities are handled correctly and potentially contentious issues are addressed.
  • Solicitors also recommend ways to use trust structures to set aside assets for the heirs while reducing the taxable value of one's estate.

Careful inheritance tax planning with professional advice can offer families considerable savings and peace of mind.

Filling Inheritance Tax Forms

When dealing with Inheritance Tax in the UK, correctly filling in the necessary forms is critical. The process involves declaring gifts and transfers, as well as the application of any reliefs that may be available on surplus income or chargeable lifetime transfers.

Completing Form IHT403

Form IHT403 is a key document for declaring gifts and past transfers when assessing Inheritance Tax. To complete this form, one must list all gifts and transfers made within the seven years prior to the date of death. This includes:

  • Gifts out of surplus income: Detailing such gifts requires a breakdown of the deceased's income and outgoing expenses to prove that these gifts were made from income, not capital, and that they did not affect the deceased's standard of living.
  • Chargeable lifetime transfers: These transfers, often made into trusts, must be accounted for even if they did not result in an immediate Inheritance Tax charge.

It is essential to provide accurate information to avoid penalties for non-compliance. Personal representatives should gather financial records and consult the Inheritance Tax guidance on gifts - GOV.UK for detailed instructions.

Declaring Gifts and Transfers

Transparency is key when declaring gifts and transfers for Inheritance Tax purposes. Gifts made up to seven years before death can significantly impact the tax payable by an estate, hence meticulous recording is advised. When declaring, consider the following:

  • Annual exemption: The first £3,000 of gifts made in any tax year is exempt from Inheritance Tax.
  • Small gifts allowance: One can give small gifts up to £250 per person each year without them being added to the value of the estate.
  • Potentially exempt transfers: Gifts to individuals may initially be exempt but can become chargeable if the giver dies within seven years of the gift date.

For comprehensive details and submission requirements, the Inheritance Tax forms - GOV.UK page is a reliable resource.

Potential Pitfalls in Inheritance Tax and Gifts

Navigating the intricacies of inheritance tax in the UK can be complex, especially when it involves gifts. Understanding the potential pitfalls such as pre-owned asset tax, loss to the donor's estate due to gifts, and gifts with reservation of benefit is crucial to minimise the tax impact on an estate.

Pre-Owned Asset Tax

Pre-Owned Asset Tax (POAT) is a tax that may apply if individuals continue to benefit from an asset they have gifted. If one gives away an asset but continues to enjoy its use or benefit, the asset may still be considered part of their estate for inheritance tax purposes. For example, if one gifts a house to their children but continues to live in it rent-free, this would trigger a POAT liability.

Loss to Donor's Estate Due to Gifts

Gifts can reduce the value of an individual's estate, potentially leading to a loss to the donor’s estate for inheritance tax purposes. While gifts may be exempt from inheritance tax if the donor survives for seven years after making the gift, if they do not, the gifted amount above the tax-free allowance (£325,000 as of the knowledge cutoff in 2023) might still be subject to inheritance tax at rates up to 40%.

Gifts with Reservation of Benefit

Gifts with reservation of benefit occur when an individual gives an asset away but retains a benefit from it. These gifts are not considered fully given away for inheritance tax purposes. For instance, if someone gives their adult child a property but still uses it, the property would still be considered part of their estate and potentially subject to inheritance tax.

Role of Lifetime Transfers and Death

In the UK, the handling of assets through lifetime transfers and at the time of death has significant implications for Inheritance Tax. Understanding these rules ensures that individuals can plan their estate efficiently.

Chargeable Lifetime Transfers

Chargeable lifetime transfers (CLTs) are gifts made during a person's lifetime that can potentially be taxed if they exceed the nil-rate band—£325,000 as of the current guidelines—and the person dies within seven years of making the gift. Transfers made to a trust or a company typically fall under CLTs. However, gifts between UK-domiciled spouses or civil partners are generally exempt.

Transfers on Death and Their Taxation

Upon an individual's death, their estate undergoes a valuation process to determine any Inheritance Tax (IHT) liability. The estate consists of all the assets held by the deceased at the time of death. The nil-rate band applies, and assets transferred to a surviving spouse or civil partner are typically exempt from IHT. However, assets transferred to others, including siblings or children, may attract IHT at 40% for the amount above the threshold, although a reduced rate of 36% applies if at least 10% of the estate is left to charity.

Frequently Asked Questions

These questions address the most important aspects concerning how gifts can affect inheritance tax liabilities in the UK.

What is the annual tax-exempt gift allowance per person in the UK?

Each individual in the UK has an annual exemption that allows them to give away £3,000 worth of gifts each tax year without them being added to the value of the estate.

What are the implications for inheritance tax when gifting large sums of money to children in the UK?

Gifting significant amounts of money to children could potentially incur inheritance tax if the donor passes away within seven years of making the gift, and the total value of the gifts exceeds the inheritance tax threshold.

Does the inheritance tax threshold in the UK apply to money gifted before death?

Yes, the inheritance tax threshold, or nil rate band, currently set at £325,000, applies to money gifted within seven years before death. Gifts exceeding this threshold may be subject to inheritance tax.

Are cash gifts to family members subject to declaration to HMRC in the UK?

Cash gifts to family members are not required to be declared to HMRC unless the donor dies within seven years of making the gift and the total value of gifts exceeds the nil-rate band.

How is the seven-year rule applied to gifts in the context of UK inheritance tax calculations?

The seven-year rule in the UK dictates that gifts given more than seven years before the donor's death are not included in the estate for inheritance tax purposes. If the donor dies within this period, the value of the gift may be subject to inheritance tax, with a sliding scale of tax relief (taper relief) applied, depending on the number of years since gifting.

What is the inheritance tax liability for recipients of gifts in the event of the donor's death within seven years in the UK?

Should the donor die within seven years of making a gift, the recipient may be liable for inheritance tax if the gift's value plus the donor's estate exceeds the inheritance tax threshold. The tax rate depends on the value of the gift and the time elapsed since it was given.

Plan wisely, plan ahead. Speak with Assured Private Wealth's pensions advisers in the UK about inheritance tax planning.

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