Gifts and Exemptions from Inheritance Tax
Quite often we are asked by clients how they can help their loved ones financially by making gifts and the tax implications of doing so.
Understanding the rules surrounding making these gifts is therefore of prime importance so that neither you nor the recipient are presented with an unexpected tax bill.
Here, we explain how the ‘Tax Man’ (HMRC) views gifts, how your annual exemption works, what gifts you can make without paying any tax and why seven years makes such a difference.
Do I need to pay tax?
The rules around gifting are set out quite clearly, so being familiar with them will ensure no unexpected tax surprises as a result of your generosity.
If you make a cash gift to another person, no tax is payable by you or the recipient at that time, but inheritance tax could become payable if you die within seven years of making the gift.
These gifts are referred to by HMRC as ‘Transfers’ and are deemed Potentially Exempt Transfers’.
Transfers (gifts) don’t have to be cash they can be assets, but if you want to gift assets (such as shares or property), you need to be aware of the tax consequences. The transfer of an asset, even if you receive no payment for it, could leave you liable for capital gains tax. This is because a transfer of the asset is deemed a disposal and so, for tax purposes, it is calculated as if you had sold the asset for its market value at the time of making the gift.
Any income or gains the recipient subsequently benefits from (such as dividends from an investment) will be subject to tax at their usual tax rates (unless the gift is from a parent and the child is under the age of 18, at which point the parent may be liable for the tax on the income).
If you die within seven years of making a gift, the value of the gift could be subject to inheritance tax. This prevents people from avoiding tax on their estate by giving away all their assets just before they die.
Annual Exemption
For inheritance tax purposes, each year you have a £3,000 allowance for making gifts, known as your annual exemption.
You can use your exemption in one lump sum or split it into smaller multiples. Any unused allowance can also be carried forward one tax year, giving you an increased limit of up to £6,000.
It is important to remember that the exemption applies to the donor (the person making the gift), not the recipient.
Exempt Gifts
Some gifts are immediately exempt from Inheritance tax, these include gifts to:
Your husband, wife or civil partner (if they are domiciled in the UK)
Qualifying charities
National institutions such as universities or museums
Some UK political parties
In addition:
As many small gifts of up to £250 as you like but no more than £250 per recipient
Wedding or civil ceremony gifts, up to certain limits, made on or shortly before the date of the ceremony. You can give up to £5,000 to a child, £2,500 to a grandchild or great-grandchild and £1,000 to anyone else
Regular gifts taken from ‘excess income’ that don’t affect your normal lifestyle
The seven-year rule
Even if your gift is not exempt, you could still avoid paying inheritance tax by surviving seven years after making it. These gifts are known as potentially exempt transfers, and after seven years, they are no longer part of your estate. If you pass away within seven years, the gift’s value will reduce the nil rate band available to your executors on your death. Gifts are assessed against your nil rate band first, so provided your gifts do not exceed the available nil rate band the recipient(s) of the gifts will not need to pay any inheritance tax. The current Nil Rate Band is £325,000 and has been at this level since 2009 and due to remain frozen until 2028 (at the time of writing).
If the gifts exceed the nil rate band, then the tax on the excess is subject to taper relief depending on how long ago the gifts were made:
| Years between gift and death | Rate of tax on the gift |
|---|---|
| 3 to 4 years | 32% |
| 4 to 5 years | 24% |
| 5 to 6 years | 16% |
| 6 to 7 years | 8% |
| 7 years or more | 0% |
The resultant IHT on failed PETs is payable by the recipient of the gift.
Making a gift to a minor or vulnerable person
Many people want to make a gift to their children, grandchildren or others who may be unable to properly manage it themselves.
This could be because they are:
Under the age of 18
Not mature or old enough to manage the money responsibly
Uninterested or inexperienced when it comes to looking after money
Going through bankruptcy proceedings
In an unstable relationship
Disabled or suffering from ill health
In these situations, instead of gifting directly you could use a different arrangement (such as a trust) to retain control over how the gift is used and when funds are distributed.
This article was prepared by Chris Green, Head of our financial planning team. We always appreciate your feedback. If you have enjoyed this article or have any specific topics you would like to see addressed in future newsletters, please email us.