Malcolm Finney discusses some of the ways in which inheritance tax on death may be mitigated.
The best way to avoid inheritance tax (IHT) is, rather unhelpfully, to die owning nothing after perhaps spending everything!
Sadly, this is somewhat impractical for most of us. However, what is perhaps not unrealistic is to consider making lifetime gifts, possibly each tax year, to family members and/or favourite charities. Gifts to charities are exempt (i.e. outside the scope of IHT), as are certain other gifts (see below).
Gifts to family members may also qualify as so-called potentially exempt transfers (PETs), which are not subject to IHT if the donor (i.e. giver) does not die within the following seven years. If, however, the donor dies within the seven-year period, a potential IHT charge arises, although this may in practice be nil, which will be the case of the gift falls within the donor’s nil rate band (currently £325,000).
Example 1: Potentially exempt transfers and the nil rate band
Sarah Turnbull made a number of PETs within seven years of her death, amounting to £300,000 in aggregate.
As Sarah died within seven years of the gifts, each gift falls within the charge to IHT. However, as the aggregate amount falls within her £325,000 nil rate band, the charge is at 0%, i.e. nil.
Not all gifts, even if the donor dies within the seven-year period, fall subject to IHT, whether or not there is a nil rate band available. Such gifts qualify as exempt gifts.
Exempt gifts
An exempt gift is simply outside the charge to IHT. Exempt gifts include:
- inter-spouse gifts;
- gifts within the annual exemption (£3,000 per tax year);
- ‘normal expenditure out of income’ gifts;
- gifts made in contemplation of marriage; and
- gifts for family maintenance.
Of the above, perhaps the normal expenditure out of income exemption and gifts for family maintenance are the two categories of gift that can be easily overlooked.
Normal expenditure out of income exemption
There is no monetary limit applicable to this exemption. The essence of the exemption is that a donor is able to make regular, typically annual, payments out of surplus (after tax) income, so long as the donor’s standard of living is not adversely affected.
Example 2: Normal expenditure out of income
Ted Bundy is retired, and receives three significant pensions from former employers. He is a widower, and does not need around 10% of his net annual income (i.e. equating to approximately £7,000 per year).
He has one daughter, Amy, and so each year he gifts Amy the £7,000 surplus income.
Gifts for family maintenance
As is the case for the normal expenditure exemption, there is also no monetary limit to this exemption.
It is designed to allow gifts to, for example, children (stepchildren and adopted children included) by one party to the marriage for the maintenance, education or training of the child (gifts must cease on the later of the child attaining age 18 and cessation of full-time education). In addition, gifts (if reasonable) may be made in favour of a dependent relative (e.g. parents and parents in law).
Example 3: Gifts for family maintenance
Bert’s mother has become infirmed and needs to go into a care home, as she can no longer look after herself. Bert contributes to the cost of the care home for his mother.
Inter-spouse transfers
Spouses are free to make gifts to each other, without limit (if the recipient is domiciled in the UK). This may then enable each spouse to make exempt gifts and/or PETs to be made to family members, etc.
Gifts made in contemplation of marriage
This is more of a one-off exemption (hopefully, no subsequent divorces!).
Depending upon the relationship between donor and the bride or groom, the amount of exemption per marriage varies:
- first £5,000 of gifts by a parent;
- first £2,500 of gifts by grandparent (or remoter ancestor); and
- first £1,000 of gifts by any other person (e.g. brother or friend of the bride).
Reliefs
A ‘relief’ applies to reduce the quantum of the gift when calculating any IHT charge.
Business property relief (BPR) is potentially the most important of the reliefs, under which the relief is either 100% or 50% depending upon the nature of the business property involved, including unquoted shares in a company not listed on a recognised stock exchange (100%); sole tradership (100%) and land, buildings and machinery used by a company controlled by the donor (50%).
Practical Tip :
Prior to the end of any tax year, review to what extent any of the exemptions and/or reliefs may have been underutilised for that year.
