Earlier this year, HMRC revealed that the 2017/18 tax year saw Brits pay out the highest ever amount of Inheritance Tax (IHT).
A total of £5.4 billion was paid during the tax year, while HMRC figures also showed that a record 28,100 deaths in the UK triggered an IHT charge in 2016/17.
There are lots of reasons why Brits are paying more IHT, from a freezing of the threshold to rising property prices. However, there are ways to mitigate a potential IHT liability during an individual’s lifetime.
A quick Inheritance Tax refresher
Inheritance Tax is paid on the estate (the property, money and possessions) of someone who has died.
There is normally no Inheritance Tax to pay if either:
- The value of the estate is below the £325,000 threshold
- An individual leaves everything above the £325,000 threshold to their spouse, civil partner, charity or a community amateur sports club
If an individual leaves their home to their children (including adopted, foster or stepchildren) or grandchildren, they can also benefit from an additional Residence Nil Rate Band, increasing the threshold to £475,000 (this will increase to £500,000 in 2020/21).
If an individual is married or in a civil partnership and their estate is worth less than the threshold, any unused threshold can be added to their partner’s threshold when they die. This means their threshold could be as much as £950,000.
Any IHT that is payable is charged at a rate of 40%, unless more than 10% of the ‘net estate’ is left to charity (see below).
Gifting is one way to reduce the size of an estate. Here are five ways that gifting can help to reduce Inheritance Tax.
1. Annual exemption
Each individual in the UK has an annual Inheritance Tax exemption, currently £3,000.
This means that an individual can gift up to £3,000 in cash or assets every tax year, and this money will not form part of their estate on death.
You can also carry any unused annual exemption forward to the next tax year, but only for one year.
As this is an individual exemption, couples could effectively gift up to £6,000 each tax year and up to £12,000 if they have not used their previous year’s allowance.
2. Small gifts
As well as the annual exemption, each individual also has a ‘small gifts’ exemption.
This means that an individual can give as many gifts of up to £250 per person as they want during the tax year, as long as they have not used another exemption on the same person.
So, for example, an individual could not make a gift of £250 to someone who they had already gifted £3,000 using their annual exemption.
3. Gifts to charity
To encourage more people to leave money to charity, any cash or assets that an individual leaves to a charity are exempt from Inheritance Tax.
This includes both gifts made during a person’s lifetime and gifts made in a will.
If an individual leaves more than 10% of their ‘net estate’ to charity (typically defined as ‘the value left over after deducting any exemptions (including your available Nil Rate Residency Band) and any other available reliefs’) the rate at which IHT is payable falls from 40% to 36%.
4. Gifts from income
One of the most valuable IHT exemptions for people who have surplus income is the exemption for ‘normal expenditure out of income’.
For this exemption to apply, it must meet three conditions:
- The gift was made out of income ‘taking one year with another’ – this means that those with variable income may be able to make gifts in excess of their surplus income for an individual year, provided that the income over a period of years was sufficient to cover the gifts
- The gift was part of the normal expenditure of the donor, based on their circumstances – generally, this means that the gifts need to be regular both in terms of frequency and value
- The donor could maintain their standard of living after giving the gift
In order to claim this exemption, executors will need to prove that a donor could afford to make the gifts out of income. They will have to outline the donor’s net income, broken down into categories, and their net expenditure for each year that they claim the donor was making exempt gifts.
This proof will be used by HMRC to assess whether the gifts made were from normal expenditure and whether they affected the individual’s standard of living.
5. Potentially Exempt Transfers (PETs)
Under the current rules, an individual can make a gift from their estate during their lifetime tax-free, as long as they survive for at least seven years after giving it.
When the gift is first made, it is called a Potentially Exempt Transfer (PET) as, assuming an individual lives for a further seven years, there will not be any IHT due on it. If they die within seven years it becomes a Chargeable Transfer.
A taper allowance does apply during the seven years, and a reduced rate of IHT is payable if an individual dies between three and seven years after making a gift. However, this applies only if the total value of PETs exceeds the available IHT threshold.
To take advantage of a PET, it’s very important that records are made of:
- What was gifted
- Who it was gifted to
- When it was gifted
- How much the gift was worth
Get in touch
If you have any questions about how Inheritance Tax works, or how to mitigate a potential liability, please get in touch with your usual RPG contact or call us on 0161 608 0000.
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