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CATEGORY - INHERITANCE TAX

LIFETIME EXEMPTIONS

Probably the most well-known of all IHT mitigation techniques is to give your property away to the next generation whilst you are still alive. There are of course some provisos to this. Most substantial lifetime gifts of money or personal property are known as Potentially Exempt Transfers or PETS and these will still form part of your estate if you are unfortunate enough to die within 7 years of making the gift.

It is important to make sure that it is not a Gift with Reservation of Benefit (sometimes known as a GROB or GRW).  For example continuing to live in a house after you have given it away would be seen as a reservation of benefit. In that instance, the taxman would disregard the transfer altogether for Inheritance Tax purposes (even though you may well still get clobbered for Capital Gains Tax) and the property would remain part of your estate when you die.

There is also a risk that you could be caught under the Pre-Owned Asset rules if you had owned the property at any time since 17th March 1986 before giving it away, or had contributed to its purchase. This could mean that you are subject to an annual income tax charge on your use or possession of the gift during your own lifetime. Fortunately, these somewhat draconian rules are only invoked by the Revenue in special circumstances where the GRW rules cannot be applied, such as with certain types of IHT avoidance schemes that happened to be legal at the time.

However, there are certain types of gift which are exempt from IHT altogether and you don’t need to worry about surviving for another 7 years. These are as follows:

  • Gifts within your annual exemption
  • Gifts worth no more than £250 each
  • Gifts on marriage (or civil partnership)
  • Gifts which are both normal and made out of surplus income
  • Gifts to your spouse (or civil partner)
  • Gifts to charities or political parties
  • Gifts for national purposes or the public benefit

Individually these are fairly small exemptions but over a number of years they could add up to a fairly substantial amount and reduce your taxable estate quite considerably. The last 3 categories apply equally to both lifetime transfers and to the estates of deceased persons. The last 4 categories are covered by our other information sheets whilst the first 3 categories are covered in more detail below.

Annual Exemption

The annual IHT exemption is £3,000. Every single person domiciled in the UK is entitled to this allowance each and every year, and if you don’t use it up one year you are allowed to carry it forward to the next tax year, so you could get up to £6,000 in any one year. Mind you, it’s not worth as much as it used to be. The £3,000 exemption has been frozen at this amount since 1981/2. If it had kept pace with inflation over the last 30 years it would now be worth over £8,000 so it appears to be one of those exemptions that are being allowed to wither on the vine.

Nonetheless, it could still add up to a substantial amount over time. If a husband and wife both used their annual exemption in full each year, after a decade it would amount to £60,000 which would save IHT of £24,000. It can be divided up between any number of people and it doesn’t matter who they are. However, if one gift takes the total for the tax year above £3,000 the excess must be treated in the usual way for IHT purposes, and if there was more than one gift on the same day the excess would have to be apportioned between them.

The annual exemption can be used for anything ranging from ordinary birthday gifts to settlements of property into a trust, and should be deducted from the value of any lifetime gifts subject to a current or future IHT charge, such as chargeable lifetime transfers and potentially exempt transfers. However, small gifts worth up to £250 will be exempt anyway so the annual exemption should really be used to cover larger gifts made out of capital (or out of income if the gifts cannot be described as normal expenditure).

Small Gifts Exemption

You are allowed to make gifts to as many people as you like (and to whoever you like) and these will be totally exempt from IHT provided that the value transferred does not exceed £250 per person in each tax year. This is another exemption that has not been changed for donkey’s years so again its real value is gradually declining with inflation.

It is an exemption that is often overlooked but can play an important part in IHT planning. In theory you could sell all your worldly possessions, divide the cash up into little bags each containing £250 and hand them out to people in the street, and there would be no IHT implications whatsoever (unless you accidentally gave more than one bag to the same person!).

More sensibly, it may be wise to use this exemption to pass cash each year to grandchildren, nephews and nieces who you would make bequests to anyway and thus reduce the IHT payable by your main beneficiaries. You never know – they might be so grateful that they do all your gardening, shopping, housework and other domestic chores for the rest of your life! Of course, the gift needs to be unconditional with no strings attached to qualify for IHT exemption. Otherwise it could be disregarded and even treated as income in the hands of the recipient, which would not please them if they were old enough to pay tax! But not even the taxman would accuse a dutiful grandchild of helping out an elderly relative simply for money, even if they do receive an annual gift of £250 on their birthday.

However, you must make sure that you don’t combine it with the Annual Exemption, because you cannot use the two together. Any gift or series of gifts to the same person in the same tax year exceeding £250 would be disallowed in full, not just the excess. This applies whether or not you use up your annual exemption on gifts for other people, although of course you would still benefit from the annual exemption if your total gifts during the year do not exceed £3,000 – even if some of them were more than £250.

Wedding Gifts Exemption

When people get married the taxman recognises that close relatives and friends like to make large gifts to the happy couple to get them off to a good start in their lives together. Therefore, the following gifts to couples getting married (or entering into a civil partnership if they happen to be gay) are totally exempt from IHT:

Parents - £5,000 each
Grandparents - £2,500 each
Remoter ancestors - £2,500 each
Bride, groom or civil partner - £2,500 each
Anyone else - £1,000 each

These limits have been frozen since 1984 and are nowhere near as generous in real terms as they used to be. However, they are probably still sufficient to cover most wedding gifts (unless you have very wealthy relatives in which case any excess would have to be treated as a PET unless it was covered by their annual exemption).

The only stipulation with this exemption is that the gift must be made (or at least promised) at or shortly before the ceremony and described specifically as being on the occasion of the marriage (or civil partnership), not for any other reason. Should the wedding be cancelled for some reason the gifts will lose their exemption. In such cases the gifts will be treated in the normal way for IHT purposes unless they are returned to the donors immediately.

Wedding gifts are often delivered after the marriage has taken place by retailers offering gift-list services. These would qualify for the exemption provided that the gift was ordered before the marriage took place. Likewise, refunds and exchanges after the marriage qualify for the exemption provided that the refund or exchanged goods belong to the married couple (or civil partners). However, where a gift is made by instructing other parties such as solicitors or brokers and it does not take place until after the ceremony, they will only qualify for the exemption if the donor informed the beneficiaries beforehand.

You need to be careful if one of the parties to the marriage (or civil partnership) is going through the final stages of a divorce or annulment. In that situation, you should make sure that the gift is not made until the previous relationship has been officially dissolved; eg when the decree absolute has been issued.

It should be noted that this exemption counts for adopted children too, and step-parents also qualify for the £5,000 limit. Parents, grandparents and remoter ancestors of step-parents or adoptive parents qualify for the £2,500 limit on the same basis.

If you choose to make a gift of a greater value than the limits above, only the excess would be disallowed and you may still be able to cover the excess with your Annual Exemption assuming this has not already been used up. It is also worth noting that the GWR rules would not apply to any assets transferred under the wedding gifts exemption up to the available limits. Therefore, the donor could continue to possess the asset even though it no longer forms part of his/her estate. Examples may include an antique or painting that would eventually be bequeathed to the married couple anyway. Such items could remain in the donor’s possession even though they now belong to the married couple, who would avoid IHT when the donor dies. It could also protect assets that continue to be used by the donor on an occasional basis (such as a car, a boat or a horse) as no reservation of benefit would be deemed to have occurred. It would have to be a pretty cheap one though to be within the limits!


Acumen Tax Solutions
2 Purley Bury Avenue, Purley Oaks, Surrey CR8 1JB
Tel: 020 8406 9425 Mobile: 07813 582890 E-mail: info@acumentaxsolutions.co.uk

For information of users: Although every care has been taken in compiling this material, it only provides an overview and does not take the place of an individual consultation. We strongly advise all users to consult the detailed legislation or seek professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or this firm.

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