Meg Saksida explains which gifts should be free from inheritance tax consequences this Christmas.
Inheritance tax (IHT), contrary to popular belief, is not a death tax but a gift tax, which means that a taxpayer can be taxed in life as well as on their estate at death.
Does that mean gifting £300 to a grandchild at Christmas is taxable? Yes it could be!
Gifting from individual to individual
When a gift is made from one individual to another, as in grandad gifting to a grandchild, this is a ‘potentially exempt transfer’ (‘PET’). If grandad survives for seven years, the gift becomes exempt for IHT purposes. It is only ‘potentially’ exempt at the date of the gift because grandad might not live that long, and if not, the gift becomes chargeable.
There is a ‘nil-rate-band’ for every individual chargeable to IHT in the UK of £325,000 (for 2020/21). If grandad has already used his nil-rate-band and dies within seven years of the gift, the grandchild would have up to £120 to pay in IHT on grandad’s gift.
No nil-rate-band left? No problem!
There are a variety of ways to ensure the Christmas gift is not chargeable, even when the donor has exhausted their nil-rate-band.
(a) Excluded transfers
Excluded transfers are transfers of property situated outside the UK where the donor is not UK domiciled.
So a non-UK domiciled individual can gift assets sited in their home country (or elsewhere in the world) without an IHT consequence.
(b) Ignored transfers
An extremely valuable exception from IHT is for gifts made to ‘maintain’ one’s family. ‘Family’ here includes a spouse or civil partner and a minor child (or over 18 if in full-time education). A ‘dependant relative’ may also be considered if they are a relative who is incapacitated by age or illness and can’t look after themselves. Although gifts between spouses are free of IHT anyway (see below) if the recipient spouse is a non-UK domiciled spouse there is a lifetime limit of £325,000, so reliance on this exception can be useful.
Gifts under this category may be of clothing, grocery vouchers, or rent. A gift for a child under this category also includes payments for education, so would include university or vocational courses and books.
(c) Exempt transfers
Up to £3,000 can be gifted in chronological gift order IHT-free every year; and if the previous year’s £3,000 exemption hasn’t been used, this can be carried forward one year. The latest year’s annual exemption is always used first.
Christmas gifts of £250 or under are exempt. This exemption can be used for as many recipients as you please, as long as the absolute gift is £250 or under. It cannot be combined with the annual exemption.
If the gift happens every Christmas and the taxpayer can afford to live in the same standard having paid the gift, it could be exempt under the ‘normal expenditure out of income’ exemption. This could be a gift of cash or an asset as long as it has a settled pattern and is paid out of income, not out of savings.
Practical tip
If grandad has used his annual £3,000 allowance as well as his nil-rate-band, he should give £250 instead of £300 to make the gift completely and easily exempt. He could gift another £50 in the next tax year. If he definitely wants to gift £300, he could consider making this every Christmas out of his income to become a ‘normal’ gift out of income, and therefore exempt.
