It is the season of goodwill and at this time of year it’s worth considering whether you want to make gifts for tax planning purposes.
Giving cash as part of a well-structured inheritance tax planning strategy is one of the easiest and most effective options available because the opportunity to gift cash without triggering a tax liability remains – for now. This article outlines the current inheritance tax rules for gifting so that if you do decide to make larger gifts than normal, you will not incur additional taxes.
Note that any gift will only be deemed to have left the donor’s estate for inheritance tax (IHT) purposes if they no longer receive any benefit from it. If you give away an asset and continue to use it, or to receive any benefit from it, then t will not be considered to have left your estate for IHT purposes. This is even the case if you are no longer the legal owner. Therefore, if you give away your home, you cannot continue to live there. The same applies to a holiday home, you cannot continue to use it if you give it away, unless you pay full market value for that use.
Any gifts made by a donor to another individual, or onto trust during lifetime may be subject to inheritance tax (IHT) if the donor dies within seven years of making the gift. If the donor survives at least three years, but less than seven years, any IHT liability will be subject to tapering relief.
Lifetime gifts made within this seven-year timeframe will firstly reduce the amount of the IHT lifetime allowance of £325,000 available to each person, with any amounts in excess of this being subject to IHT on death at 40%. It is this liability on the excess which will attract tapering relief after 3 years.
How much can be gifted tax free?
For tax purposes, cash is the most straightforward asset to gift and can be given away tax-efficiently with no immediate tax charge because it is not a ‘chargeable asset’ for capital gains tax (CGT) purposes.
From an IHT perspective, gifts made to another individual are ‘Potentially Exempt Transfers’ (PETs) – in the case of PETS, as long as the donor survives seven years from the date of the gift, it will be outside their estate entirely and will not be subject to IHT on their death. If the donor survives for at least three years, taper relief will be applied to the 40% rate.
Gifts made onto trust are not PETs, they are ‘Chargeable Lifetime Transfers’ (CLTs); any amount of gift onto Trust which exceeds £325,000 in value will attract IHT at the time of gifting at the lifetime rate of 20%. These types of gift can be useful for personal reasons, but also when gifting chargeable assets that attract CGT, because the CGT arising can be ‘held over’ when the gift is a CLT rather than a PET.
Gifts of personal belongings
The main problem with gifting assets for IHT planning purposes is that they will trigger a CGT charge if the asset has increased in value since originally acquired. This is because gifting is treated as a disposal at market value for tax purposes.
If you want to make a gift to an individual, and avoid CGT, then unless you want to consider gifting onto trust, you might want to consider gifting personal belongings.
Personal belongings are termed ‘chattels’ for tax purposes – for example, furniture, cars, paintings, jewellery, antiques.
There are specific rules regarding the calculation of CGT for chattels and a disposal may be exempt from CGT or may attract favourable relief.
If you gift an asset that is worth less than you paid for it, this will create a capital loss. The loss can be offset against other capital gains arising in the current tax year or can be carried forward to offset against gains of future tax years. If however the loss arising relates to assets gifted to a connected person like a family member, the ability to carry forward the loss may be restricted.
Regular gifts out of excess income
One of the most valuable forms of IHT relief is a gift made from surplus income. This is because the seven year rule does not apply to these gifts and they fall outside the estate of the donor immediately.
Such gifts must be regular in nature, with an intention to continue, and the donor must have sufficient income after the gifts are made to continue their usual standard of living. Regular payment of school fees, or for music lessons, or insurance policies for example can qualify.
It is important to retain good evidence of net income and all outgoings to evidence that regular gifts are in fact made out of excess income.
We all know that giving is better than receiving, and if gifting helps to reduce the value of your estate for IHT purposes, it is even more rewarding. It is always important to consider the tax consequences and follow the rules to ensure than no unforeseen tax charges will arise in the future. Bear in mind that if you give something away you cannot continue to use it and, gifts made from income must be seen to be sustainable.
If you would like to discuss your inheritance plans to minimise tax, contact us via partners@rjp.co.uk.