Do gifts made in a person’s lifetime reduce the inheritance tax to be paid on death? This is a query we often hear, both from individuals who are thinking about planning for the future and from people who are acting as executors for a deceased family member or friend.
In general terms, inheritance tax is paid based on the value of the assets you own at the date of your death, after deducting any debts you owe at that time. In valuing your estate, assets you own in your sole name and your share of those owned jointly with others is taken into account, and the value of any gifts or transfers you made in the seven years before your death is also added in. Each individual has an inheritance tax free allowance, currently of £325,000, and inheritance tax is paid on the net value of your estate which is above that figure. In certain circumstances, a further inheritance tax allowance in relation to residential property can be used as my colleague discussed in her recent article
There are a number of different ways to gift, which can mitigate the inheritance tax to be paid on your estate:
1. Small gift exemption
Small gifts of up to £250 per person each year can be given. If you give more than this to one individual, however, the whole amount they receive could then be subject to inheritance tax.
2. Annual gifting exemption
In addition to the small gift exemption, each individual can make larger gifts up to a total value of £3,000 per year. If in one year you do not make any gifts, your £3,000 exemption can be carried forward to the following year but this can only be done once.
3. Gifts on marriage/civil partnership
Gifts can be given on a marriage or civil partnership. The allowance differs, depending on your relationship to the recipient. Gifts of up to £5,000 can be made to your child; up to £2,500 to your grandchild or great-grandchild; and up to £1,000 for extended family or friends.
4. Gifts to charities and/or political parties
Gifts made to charities or political parties will be exempt from inheritance tax.
5. Gifts out of surplus income
If your income exceeds your expenditure then you may choose to make gifts from your remaining income. HMRC will examine your finances very carefully to determine whether the gifts were certainly made from surplus income, and not from capital, and in addition would want to be satisfied that your standard of living had not been adversely affected because of the gifts being made. HMRC would generally expect to see a pattern of gifts being made from surplus income, for usually at least a consecutive three year period. If you are considering making use of this tax relief you should keep full records of your income and outgoings, including copies of any tax returns.
6. Gifts made from capital
If you survive at least seven years after making a gift, the value of that gift will not be taken into account in the value of your estate on your death.
In the event that you give gifts and die within seven years of making them, if the total value of them exceeds your inheritance tax free allowance then a reduced rate of tax (known as taper relief) would apply to gifts made more than three years before your death. The oldest gifts would be set against your inheritance tax free allowance first, and the remaining gifts would be taxed on a reducing scale, depending on how many years had passed between them being given and the date of your death. For example, gifts made 5 to 6 years before your death would be taxed at 16% with those made 4 to 5 years before being taxed at 24%.
If inheritance tax is payable on gifts made in your lifetime, the recipient of the gift will be liable for paying the tax due and so this is something you should consider and make sure they are aware of at the time you make the gift.
Gifting can be an effective way of lowering the inheritance tax paid on your death, but this is, of course, only a general outline of the exemptions and reliefs available. If you are thinking about inheritance tax planning, there can be significant benefits in obtaining professional advice.
Alternatively, if you are an executor you have a duty to submit comprehensive and accurate inheritance tax returns to HM Revenue and Customs. Ensuring the correct reliefs are applied and properly calculated is a very important consideration and can impact on the amount the beneficiaries inherit. Our estate administration team can assist in preparing the estate paperwork and administration matters on your behalf.