How lifetime gifts can help you reduce Inheritance Tax

by Kirsty Royds-Jones, Knill James Tax Manager

Are you making the most of these Lifetime Inheritance Tax exemptions?

Most people know that if you make a gift during your lifetime then survive the next seven years, your gift falls outside the Inheritance Tax net.

But did you know that there are several other exemptions available when making lifetime gifts? And with these you don't have to wait for seven years before you can be confident that your gift is free from Inheritance Tax.

Eight Common Lifetime Inheritance Tax Exemptions

1. Annual Exemption - £3,000
2. Small Gifts Exemption - £250
3. On Marriage/Civil Partnership of your Child - £5,000
4. On Marriage/Civil Partnership of your Grandchild/Great Grandchild - £2,500
5. On Marriage/Civil Partnership of any Individual - £1,000
6. Gifts to Spouses/Civil Partners where both are UK domiciled - No Limit
7. Gifts to Charities - No Limit
8. Gifts to Political Parties, Housing Associations, for National Purposes - No Limit

And don't forget that with all these exemptions:

• If you don't use your Annual Exemption in one tax year, it can be carried forward to the next.
• With the Small Gifts Exemption, gifts of up to £250 can be made per person in each tax year. This is often used to cover Birthday and Christmas gifts.

Gifts out of income

This is another less common Inheritance Tax Exemption that can apply to lifetime gifting, although there are two things to note:

1. Your gift must meet certain requirements

• Your gift must form part of your normal expenditure and must be made on a regular basis, such as once a month or once a year. It's important that a regular pattern of gifting is set up if you wish to use this exemption.
   
• It must be made out of your excess income. Once the gift has been made from your income, you must still be left with enough income to maintain your usual standard of living. This includes the amount that you would usually spend on leisure activities, socialising and holidays and not just food and bills.
   

2. Make a note of your intentions

• If you wish to use this exemption, then it is a good idea to put your intention in writing. A letter to the Donee simply setting out the amount and pattern of the gift, together with confirmation that this will be made from your excess income should suffice.
   
• It is important to note that this exemption is claimed when the Inheritance Tax account for your Estate is submitted to HMRC after you have passed away. Problems often arise for Executors when trying to find records of the Deceased's expenditure for the previous seven years in order to justify a claim for this exemption.
   
• If you choose to use this exemption, then it is good practice to set up a spreadsheet that keeps a record of your income and expenditure, so this exemption can be easily claimed when the time comes. Appendix A shows the HMRC schedule that must be completed to claim this exemption.

Co-ownership and occupation of your home

The most significant asset in many UK Estates is someone's home. There are no Lifetime Inheritance Tax Exemptions that apply to the family home and on face value there is little Inheritance Tax planning that can be undertaken to minimise the Inheritance Tax exposure of this asset.

1. Giving away your home
   If you choose to give away your home, then this is treated as a Potentially Exempt Transfer. You must therefore survive for seven years from the date of the gift for it to fall outside the Inheritance Tax net.
   
   It's important to be aware that if you continue to live in your home, then you must pay a market rent to the Donee for the privilege of doing so, if you wish for this to be an effective gift for Inheritance Tax purposes. Otherwise, the gift is ignored and your home will still be included as an asset of your Estate when you pass away.
    

2. Shared occupancy
   Another option available is shared occupancy. Using this planning, you can gift up to 50% of your home to an individual(s) who must then move in to live with you in your home. You retain the ownership of the remaining 50% of your home and also continue to live there. Bills should be split accordingly between all occupants.
   
   This is still a Potentially Exempt Transfer and therefore you must survive for seven years from the date of making the gift for up to 50% of the value of your home to fall outside of the Inheritance Tax net. This option is clearly not suitable for all, but can work well where generations are already living together or younger generations decide to move in to care for elderly relatives.

How taper relief works

If your lifetime gift planning does not work out and some of your lifetime gifts become chargeable to Inheritance Tax after you have passed away, then taper relief may be available to reduce the Inheritance Tax now payable by the Donee who received the gift.

However, many people are not aware that your nil rate band of £325,000 is first set against your lifetime gifts that become chargeable when you pass away rather than the rest of your Estate.

On the plus side, this means that if you have made lifetime gifts under the value of £325,000 which have become chargeable, then no further Inheritance Tax will be payable by the Donees. On the other hand, more Inheritance Tax will now be due on the assets that make up your Estate because the nil rate band is no longer available to set against this.

It therefore follows that taper relief only comes into play if you have made lifetime gifts that become chargeable to Inheritance Tax after you have passed away which are in excess of £325,000.

Here to help

Are you concerned about your Estate's current exposure to Inheritance Tax? Would you like advice on Lifetime Gifting and Inheritance Tax planning ideas? If so, please get in touch with us on 01273 480480 or email Kirsty Royds-Jones on kirstyr@knilljames.co.uk and she or one of our tax team's experts will be pleased to help.