The hidden inheritance tax on gifts
Posted on: 30-05-2023
The hidden inheritance tax on gifts | Dunhams News Blog
The usual advice is that potential inheritance tax (IHT) payable on gifts starts reducing (tapering) once three years have elapsed, and after seven the gift is IHT free. However, the three-year deadline is often an illusion. Why?
The simplest way to reduce inheritance tax (IHT) on your estate is to give away as much of your wealth as you can afford while you’re alive. The trouble is the IHT rules say that the value of any gifts you make within seven years before your death still count when IHT is calculated on your estate. However, a partial reduction, known as IHT taper relief, can apply after just three years.
If, after making a gift you survive at least three years the IHT bill relating to it will be reduced (tapered) as follows:
|Years survived||Reduction in IHT|
|Between three and four||20%|
|Between four and five||40%|
|Between five and six||60%|
|Between six and seven||80%|
|Seven or more||Exempt|
The trouble is another factor in the IHT calculation can nullify the taper relief.
The taper trap
Gifts made during the last seven years of your life are only taxed when in total their value is greater than the IHT nil rate band (NRB) (currently £325,000) and if applicable the residence nil rate band (RNRB). Until your estate surpasses the NRB and RNRB (where is applies) IHT is payable in respect of them and if there’s no IHT there’s nothing to which IHT taper relief can apply.
Example. Six years ago you inherited your mother’s estate of £900,000. To reduce IHT she made gifts totalling £300,000 to you and other members of the family. She died before seven years had elapsed. Assuming the rest of her estate remained unchanged IHT is worked out as follows:
|Estate at death||£900,000|
|Nil rate band||(£325,000)|
|Lifetime gifts within seven years of death||£300,000|
|Annual exemptions year of gift and previous one||(£6,000)|
|Residence nil rate band||(£175,000)|
|Balance of nil rate bands||£206,000)|
|Estate chargeable to IHT||£694,000|
|IHT payable at 40%||£277,600|
The lifetime gifts use the NRB and RNRB before the IHT is worked out on the estate. This means no IHT is payable on them and so there’s no taper relief. The effect of this is that the IHT bill has been increased by the full IHT rate on the value of the gifts, i.e. £120,000 (£300,000 x 40%).
Avoiding the trap
Unfortunately, the trap can’t be avoided but you can plan around it. If you’re in good health take out term life assurance for a period of seven years from the date of the gift. That will meet the IHT bill should you die before that time is up. Buy into insurance-based IHT saving schemes that immediately reduce your estate for IHT purposes, e.g. discounted gift schemes. You could also buy investments that qualify for 100% IHT business property relief, e.g. shares in unlisted companies.
If you would like any assistance with any of these points.