Posted on Dec 16, 2016 in Private Client by Lorna Goodfellow
At this time of year, gifting for Christmas is a priority but gifting throughout the tax year could mean significant Inheritance Tax savings for you and your family.
What constitutes a gift?
A gift is broadly anything of value and could be cash, paintings, jewellery, investments or property. It could also be a loss in value, for example if you were to sell something to someone at below market value.
There are various exemptions for inheritance tax which can make a difference to your overall position when used consistently over a period of time. Some of the most commonly used are as follows.
Small gift exemption
You can give £250 to as many people as you wish during the tax year and this will be exempt from inheritance tax. Essentially, this relief is designed to cover birthday and Christmas gifts but it is important to be aware that you cannot give more than £250 to the same person and you cannot give a person £250 if you’ve already given them a gift using another exemption.
Each of us has an annual exemption of £3,000 which can be given away tax free each year. If you did not use this relief last year, then it can be carried forward for one year only. Someone who has never made use of the exemption could give away £6,000 this tax year and £3,000 each tax year thereafter.
When thinking of how to use the relief practically you might choose to give each of your children £1,500 per tax year if you have two children or £1,000 each per tax year if you have three children. The relief applies per person so a married couple or those in a civil partnership would each have £3,000 which they can utilise.
The sums involved may sound minor but if used consistently over a period of time the annual exemption can be a useful way of reducing your overall inheritance tax liability.
The small gift allowance and the annual exemption do not work together so it would not be possible to give £3,250 to one person and expect the total sum to be exempt.
Gifts in consideration of marriage or civil partnership
Depending on your relationship to the happy couple you may be able to obtain relief on gifts in consideration of marriage or a civil partnership. Parents can give £5,000 to a child, grandparents can give £2,500 to a grandchild and for anyone else the limit is £1,000. The gift must be made on or shortly before the marriage or registration, to one or both parties, and the exemption only becomes fully effective when the marriage or registration takes place. As the gift must be made to one of the parties paying for part of the wedding directly would not qualify.
Normal expenditure out of income relief
Another exemption which is often overlooked is normal expenditure out of income relief. Where you have excess income which you do not need in order to live then you can gift away the surplus free of inheritance tax.
The gifts should be made as part of the normal expenditure of the donor, they should be made from income and they should leave the donor with sufficient income to maintain their normal standard of living. “Normal” in this sense would mean standard, regular, typical or habitual of the donor. The relief is not subject to an upper maximum so it is a useful exemption for those with large incomes.
The claim for relief is made on death and it is necessary to show that there was surplus income available from which to make the gifts. Where no records have been kept this is done by examining historical bank statements to determine levels of income and expenditure per tax year. Good record keeping assists hugely in making a successful claim and a good starting point would be to keep a note of annual income and expenditure.
It is also necessary to show a pattern of giving although this does not mean that the same amount must be gifted to the same recipient. The amounts and the beneficiaries can vary but the donor must show a commitment to making the gifts.
The setting up of a standing order would seem sensible and those considering making use of the exemption may also wish to write a letter to those they intend to benefit confirming that they wish to begin making gifts out of excess income.
Gifts out of income do not have to be made to individuals outright. Excess income could be used to pay premiums on a life policy, school fees or could be paid in to a Trust.
Potentially exempt transfers
If you wish to make a gift larger than the annual exemption then provided you survive for seven years from the date of the gift, the gift will fall out of your estate for inheritance tax purposes. Such gifts are called Potentially Exempt Transfers or PETs. The gift could be of cash, a property, a painting or even jewellery but the important thing is that it must be a true gift which means that the donor cannot retain any benefit from the gift in order to start the seven year clock running.
If you have a second property that you rent out, you might decide to gift this to your children but you could not continue to receive the rent after the gift has been made. If you own a holiday home, you could gift this to your children but you would need to consider how often you stayed there after the date of the gift and if you did whether you should be paying a market rent for your use of the property.
If you do retain any benefit from the gift then the seven year clock will not start running until you give up that benefit. Such failed PETs are called gifts with reservation of benefit.
If you were to pass away within the seven year period then the value of the gift would eat in to your nil rate band or exempt amount for inheritance tax (currently £325,000). Taper relief would only come in to play if the value gifted was over the nil rate band. It is the tax that is tapered and the taper relief applies on a sliding scale from years three to seven from the date of the gift as shown below.
Years between gift and death
To gift or not to gift?
If inheritance tax is an issue, it can be difficult to know when to start making significant gifts to reduce any potential inheritance tax liability. None of us knows how long we will be here or indeed what our needs may be in the future.
There can also be genuine concern about handing over significant assets to your children or other relations if their personal circumstances are complex or it could be the case that they are simply not very good with money.
If your family situation is uncertain and you do not wish to make outright gifts to individuals then it may make more sense to gift to a Trust as this would allow you to retain some control.
Gifts to Trusts
If you make a gift to a Trust during your lifetime then if the gift falls below the value of the nil rate band for inheritance tax there will be no charge to inheritance tax when the gift is made. Setting up a Trust during your lifetime can allow you to make larger gifts where perhaps you would be uncomfortable gifting to an individual for whatever reason.
It would be possible for someone setting up a lifetime Trust to become a Trustee of that Trust so that they could continue to have an ongoing involvement in any decisions made regarding the funds.
Many of us receive inheritances when we are already comfortably off ourselves and it is the next generation who could really use a helping hand. Entering in to a Deed of Variation allows a beneficiary to rewrite the Will of someone who has passed away so that their inheritance passes to someone else. If a Deed of Variation is put in place the funds are deemed to have been given to the new beneficiary by the person who has passed away thus bypassing the seven year rule. Such deeds are often used to pass assets down to the next generation and must be entered in to within two years of the date of death.
Resolving to take some time to look at your overall financial position and to consider whether you could or should be making use of some of the exemptions available might be the best thing you could do for you and your family this coming New Year. Each person’s situation is unique and advice tailored to reflect your own personal circumstances is essential.
Lorna Goodfellow is an Associate in our specialist Private Client team. For more information on gifting and Tax benefits contact Lorna on 01382 229111 or e-mail email@example.com, alternatively contact any member of our private client team.