The main season for exchanging presents may be over, but many readers will from time to time consider the benefits of gifts when inheritance planning. James Mabey, a partner at law firm Winckworth Sherwood, talks through the tax implications of lifetime gifting.
In England and Wales there is no limit to the amount you can give away during your lifetime, but gifts may be counted as part of your estate on your death and are potentially liable to Inheritance Tax.
There are a number of Inheritance Tax exemptions available for lifetime giving. In this article we will review the main exemptions still available to be used and some of the pitfalls of these exemptions.
The exemptions
An outright lifetime gift, made with no strings attached, is known as a “Potentially Exempt Transfer” (PET). It is potentially exempt from Inheritance Tax, because whether it is counted as part of your estate or not on your death, depends on when the gift was made. If you survive seven years from making the gift, then it will drop out of your estate and be exempt from Inheritance Tax. However, if you die within seven years of making the gift, it will be counted as part of your estate, although the amount of Inheritance Tax on the gift can start to reduce after three years.
The main Inheritance Tax exemptions available which allow you to make lifetime gifts, within certain thresholds, that will be free of Inheritance Tax and will not be added to the value of your estate on your death, irrespective of how many years have passed, are as follows:
- Annual exemption: This allows you to gift, to either one person or split between several people, up to a total of £3,000 each tax year, free of Inheritance Tax. If you do not use your £3,000 annual exemption, you can carry this forward one tax year.
- Small gift allowance: This allows you to gift up to £250 per person, to an unlimited number of people, each tax year. You cannot use this allowance when making a gift to an individual that you have already used another exemption on.
- Normal expenditure out of income: This is a very useful exemption which allows you to make regular gifts to another individual, free of Inheritance Tax, as long as the gifting leaves you with sufficient income to maintain your normal standard of living. This exemption is currently uncapped in the amount you can gift.
- Gifts made in consideration of marriage or civil partnership: You can gift up to the following amounts to someone who is getting married or entering into a civil partnership, and the amounts depend on your relationship with the recipient.
- £5,000 to a child.
- £2,500 to a grandchild or great-grandchild.
- £1,000 to any other person.
The gift can be combined with another exemption, but not the small gift exemption, such as the annual exemption to allow you to gift a larger amount.
- Gifts between spouses or civil partners living in the UK, and gifts to charities and political parties: These exchanges are also exempt from Inheritance Tax.
The pitfalls
The most common pitfall when trying to rely on one or more of these exemptions is poor record keeping. If accurate records have not been maintained during a lifetime, on the giftor’s death, executors are often faced with the difficult task of sourcing information spanning seven years before the death, or sometimes up to 14 years, if gifts have been made to trusts. Record keeping is especially essential if the normal expenditure out of income exemption is to be relied on – part of the disclosure on death includes setting out the deceased’s annual income and expenditure, for each year the exemption is being claimed, to show a surplus exists to cover the gifts made.
Some other pitfalls include failing to take into account the interaction between the different exemptions and making a gift of something that you still benefit from (contravening the “no strings attached” basis of PETs).
Furthermore, many may not be aware that the “Nil Rate Band” (the first £325,000 of your estate, which is subject to a 0% rate of inheritance tax) is allocated to lifetime gifts first, in the order that they were made, with any balance remaining used against the rest of your estate. In addition, the primary liability for any Inheritance Tax payable on a lifetime gift is with the recipient of the gift. Both these factors can result in potentially more or less being received in the hands of the recipient than was intended by the giftor.
So in summary…
Lifetime gifting can be very rewarding, allowing you to see the impact of your gift whilst you are still alive. If you would like to better understand how lifetime gifting could affect your financial arrangements, please get in touch.
James Mabey is a partner, specialising in private wealth, trusts and tax, at law firm Winckworth Sherwood. He will be talking at this year’s Forecourt Trader industry Summit on February 25 on how to position a company’s affairs for succession.
This column is from legal practitioners Winckworth Sherwood LL. Neither of Winckworth Sherwood or Forecourt Trader shall be liable for any decision or action taken on the basis of it. Nothing in this column constitutes legal advice or gives rise to a solicitor/client relationship. Specialist legal advice should be taken in relation to specific circumstances.
