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Amongst the most essential inheritance tax planning considerations are the inheritance tax rules surrounding lifetime gifts. Inheritance tax rules are highly complex and, thus, will require one of our solicitors to thoroughly explain and advise on these rules when considering inheritance tax planning.
What is inheritance tax planning?
Most people know that inheritance tax is payable on larger estates, specifically those over £325,000. It’s charged on property and money acquired by gift or inheritance.
What people do not know is that the tax must be paid from the estate, rather than from beneficiaries directly.
Inheritance tax planning involves putting in place an inheritance tax strategy during a person’s life to reduce their overall inheritance tax bill on death. An effective inheritance tax strategy can completely eliminate any inheritance tax due if properly executed, maximising what’s passed on.
What are lifetime gifts and why are they important?
A lifetime gift is a sum of money given away before someone dies.
These gifts are usually counted as part of an estate if the person who gave them dies within 7 years making the gift. They also attract a 40% tax rate that reduces, or ‘tapers’ over the 7 years.
However, if you live longer than 7 years from the date you made the gift, they will be exempt from any inheritance tax that would otherwise have been due.
This is important as it effectively allows people to reduce the size of their estate and avoid having to pay as much, or any inheritance tax on death.
As a result, early planning of how to pass on your assets is essential.
There are other exemptions beyond the 7 years tapering rule that are useful to bear in mind when planning your estate.
Inheritance tax rules on lifetime gifts.
Below are the most common inheritance tax exemptions on lifetime gifts. Helpfully, these exemptions’ stack’, meaning they all apply at the same time. As a result, it’s not a matter of choosing the best or most applicable exemption.
1. Spouse/civil partner exemption.
Below are the most common inheritance tax exemptions on lifetime gifts. Helpfully, these exemptions’ stack’, meaning they all apply at the same time. As a result, it’s not a matter of choosing the best or most applicable exemption.
2. Normal expenditure out of income.
Lifetime gifts are exempt from inheritance tax if they form part of the donor’s (the ‘gift giver’) average expenditure out their net income (after-tax).
For this to apply, there must be a regular pattern of spending. A regular pattern can be as frequent as every week or as infrequent as annual gifts, such as the payment of school fees. The donor must be left with sufficient income to maintain their usual standard of living on a weekly, monthly, or annual basis (depending on the regularity of the gift).
This exemption can be problematic to prove, and it requires an analysis of the deceased’s bank accounts after they have died and very detailed forms to be submitted to HMRC.
If there is sufficient evidence, the first in what would have been regular gifts can be an exemption if proved that the donor had the intention to make a series of gifts.
3. Small gifts to one person.
Lifetime gifts of up to £250 to any one individual during a tax year are exempt from inheritance tax. This exemption is only available if the gift (or gifts) to that individual do not exceed £250 throughout the tax year. Unlike the general annual exemption (see point 5), this money can’t be carried forward to the next tax year.
The amount of the gifts a person is giving any one individual must be considered carefully during the inheritance tax planning process. If an individual makes several gifts throughout the tax year and they add up to £275 then no part of the donations will enjoy the small gifts exemption. It may come within other exemptions, but this one will not apply. Good inheritance tax planning can take advantage of all these gifts.
4. Wedding and civil partnership gifts.
Lifetime gifts can be made on the occasion of a marriage or registration of a civil partnership. These will be exempt up to a specific limit which is calculated depending on the donor’s relationship to the couple “tying the knot”.
Each parent can give £5,000 to the couple, a grandparent may give up to £2,500, and any other person could provide £1,000 free from any inheritance tax consequences.
However, difficulties arise if the ceremony does not take place as the exemption is then not valid. The exemption still stands, even if the gift was sent and spent before the cancellation of the ceremony.
5. Annual exemptions.
Lifetime gifts will not be subject to inheritance tax if they fall below the total threshold of £3,000 per tax year. This rule will help if you currently or intend to make gifts for birthdays and Christmas, which exceed £250 to an individual over one tax year.
This threshold applies to the total gifts given by the donor in any one single tax year, it’s not a threshold that applies to each person to whom you give gifts.
You can also carry over any unused amount of your annual exemption to the next tax year. Meaning that if you do not give any gifts in one tax year, you can provide gifts totalling up to £6,000 in the next tax year without any inheritance tax consequences.
6. Gifts to charities and political parties.
currently, outright gifts to UK, EU, Norwegian, Icelandic and Liechtenstein charities are exempt from the payment of any inheritance tax. However, this may change soon. There is also a reduced rate of inheritance tax applicable to the estates of deceased individuals who leave 10% or more of their net estate to charity.
Gifts to UK political parties are exempt from inheritance tax as long as at least two members of the party were elected to the House of Commons in the last general election, and at least one member of the party was elected. Additionally, there will need to be at least 150,000 votes given to candidates who were members of that party.
Anti-avoidance rules relevant to inheritance tax planning
There are specific rules applicable to lifetime gifts or structuring put in place which can disrupt these exemptions from applying. They are complicated, and if you are concerned about whether they may apply to your situation, then you should always seek legal advice. The rules are summarised briefly, as follows:
- Gifts with reservation of benefit: These rules apply where the donor ‘gives away’ an asset, but the donor retains the whole or some part of the benefit from the property. A helpful example may be ‘giving away’ a painting, but it remains hanging in your property, or even making a gift of your house but retaining occupation of part of it. If these rules apply, the asset is considered to remain part of the donor’s estate and will be taxed as such.
- Pre-owned assets: These rules apply where an individual gives away property (which is defined to include land, buildings, chattels, money and investments) and subsequently benefits from the gifted property. This is a charge to income tax, and there will be a market-based ‘rent’ applied to the asset on which income tax is payable.
What about when gifts don’t fall within any of these exemptions?
If no exemption applies to a lifetime gift, it does not mean that inheritance tax is payable straight away.
Regardless of the nature of the gift, it’s likely the 7 years tapering rule will apply, so if the person who gave the gift lives for longer than 7 years, the gift will likely not incur inheritance tax.
Why contact our inheritance tax solicitors?
Inheritance tax planning isn’t a straightforward procedure. Lifetime gift-giving requires help from an experienced solicitor, to ensure that you’re planning is in line with the inheritance tax rules, giving you that peace of mind.
If you have any questions, regarding inheritance tax, please call one of our solicitors in Brighton directly on 020 3007 5500 or send us an email at [email protected].
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