Gifts and their effect on inheritance tax

Last updated on September 29th, 2022 at 08:16 pm

Click on the links below to jump to each section and find out more.

• Gifts to your spouse or civil partner
• Gifts to your children and others
• Reservation of benefit
• Gifts to charitable organisations
• Small, regular gifts to your children
• Other gifts that are exempt from IHT
• What is taper relief?
• Responsibility of your personal representative relating to gifts
• How can Graysons help?

 

Gifts to your spouse or civil partner

Your spouse or civil partner can inherit your whole estate without paying IHT.  They can also inherit all or some of your tax-free allowance (nil-rate band), which will then increase the amount they can pass on, tax-free, when they die.

The nil-rate band – the amount you can leave when you die before IHT is payable – is currently £325,000. If you are leaving your main residence to a lineal descendant, you will have an additional tax-free allowance, called the residence nil rate band (RNRB).  During 2019/20 this allowance is £150,000 but will rise to its final limit of £175,000 in 2020/2021.  The RNRB can also be passed to your spouse or civil partner when you die, meaning that up to £1 million can be left, IHT free when the second of a married couple or a couple in a civil partnership dies.

You can gift as much as you like to your spouse or civil partner during your lifetime and no IHT will be payable on that when you die, provided you both live in the UK.  However, capital gains tax may be payable if the gift is not cash but consists of property or shares in a business, for example. You should take professional advice relating to this issue.

Please note that if you are not married or in a civil partnership, your partner cannot inherit your estate IHT free and cannot inherit your nil rate band and residence nil rate band.

Gifts to your children and others

You can gift as much as you like to your children and others during your lifetime, and if you survive at least seven years after the gift is given, no IHT will be payable on the value of the gift.  Gifts given in this way are called potentially exempt transfers.  If you die within seven years of giving the gift, it becomes a chargeable transfer and IHT is payable on the whole value. However, a further IHT relief known as taper relief can apply in qualifying circumstances.

Giving away your house or selling it and giving away the money is treated in the same way as this. If you survive seven years after it is given away, IHT will not be payable (unless you continue to live in it rent-free).  If you sell your house for less than its market value and you die before seven years are up, the difference between the sale value and the market value will be treated as a gift.

Note that cash gifts to your children who are over the age of 18 will not affect their own income tax as HMRC does not count gifts as income.  They will, however, have to pay tax on any interest the gift earns if it is invested and the gift could affect any benefits that the child receives. Capital gains tax may be payable on non-cash gifts.

The situation is different if you give gifts to children under the age of 18.  Whilst you can give as much money as you like to them, they can only earn £100 a year interest, tax-free.  Tax will then have to be paid on any interest above £100 as if the interest was yours.  This only applies to money given by parents and not by grandparents or other family members.  Interest earned on savings in a junior ISA does not count towards the £100 tax-free interest mentioned above.  There is a maximum amount you can pay into a junior ISA, which is £4,368 in the year 2019/2020. Find out more about junior ISAs here.

Reservation of benefit

If you give away an asset but continue to benefit from it, the asset will need to be valued and included in your estate for IHT purposes.  The seven-year rule does not apply in this case.

This means that if you give your house to your children, for example, but you continue to live in it rent-free, the house will still be considered as part of your estate and IHT will be payable on it when you die.

There are other circumstances in which gifts can be given with a reservation of benefit so you should take professional advice on this issue.

Gifts to charitable organisations

Any gift that you leave to qualifying charity or charitable organisation – either upon death or during your lifetime – will reduce your inheritance tax.  The value of the gift will be deducted from your estate before IHT is calculated.  Also, if you leave more than 10% of your net estate (the taxable amount after exemptions and the nil rate band is applied) to charities, IHT liability will be reduced from the standard 40% to 36%.

Small, regular gifts to your children

You can make small, regular gifts to your children out of money on which you have already paid income tax, provided they do not affect your normal lifestyle, and the value of these gifts will not count towards IHT no matter when they are given.  This includes gifts made at Christmas, birthdays and anniversaries or payments such as insurance premiums or into a savings account.

Other gifts that are exempt from IHT

• The annual exemption. This covers gifts made up to the value of £3,000 a year during your lifetime – all or some of which can be rolled over to the following tax year, making it possible to gift up to £6,000 in one year.  This is the exemption for one person, so a couple could make gifts of up to £6,000 in one year and if they both do not use the exemption in one year, they can both roll over the exemption and leave gifts up to the value of £12,000.
• Gifts for a wedding or civil partnership. You can give each child up to £5,000, each grandchild up to £2,500 and anyone else up to £1,000.  This is the limit of gifts that can be made in each year.
• Money to help some dependants with living costs. This can be a spouse or ex-spouse, a civil partner or ex-civil partner, children under 18 or who are in full-time education or elderly, ill or disabled dependants.
• Small gifts of up to £250 per person, as long as a gift doesn’t go to someone who has benefited from one of the other exemptions. You can give as many of these each year as you like.
• Gifts to some national institutions, such as universities or museums.
• Gifts to political parties. The party must have at least two members in the House of Commons following the last election before the donation is made, or one member and the party had received at least 150,000 votes.

What is taper relief?

Taper relief comes into effect when the cumulative value of any gifts within the seven years prior to death exceeds your IHT allowance (i.e. £325,000). IHT is payable at the following rates on any gifts given in excess of this during the seven years before you die, as follows:

Less than 3 years	100% of the IHT payable on the gifts – 40%
3 – 4 years	80% of the IHT payable on the gifts – 32%
4 – 5 years	60% of the IHT payable on the gifts – 24%
5 – 6 years	40% of the IHT payable on the gifts – 16%
6 – 7 years	20% of the IHT payable on the gifts – 8%
7 years	No IHT payable

The government website gives the following example:

Sally left three gifts in the seven years before she died.

• £300,000 to her brother 6.5 years before her death
• £50,000 to her sister 4.5 years before her death
• £150,000 to her friend 3.5 years before her death

Sally is not entitled to any other gift exemptions or reliefs.

There’s a £325,000 inheritance tax threshold. Anything below this amount is tax-free.

£300,000 is used up by the gift Sally gave her brother. There’s no tax to pay on his gift.

The remaining £25,000 is used up by her £50,000 gift to her sister. There’s tax to pay on the amount not covered by the threshold. That means there’s tax to pay on £25,000 of the gift to Sally’s sister at a rate of 24%.

The £150,000 gift given to her friend is taxed at a rate of 32%.

IHT is payable at 40% on all of the rest of the estate.

Responsibility of your personal representative relating to gifts

If you make any gifts during your lifetime, it is a good idea to keep records, as your personal representative will need to make sure that all gifts are fully investigated and reported to HMRC so that liability for IHT can be calculated.

How can Graysons help?

Anne Rogers, head of our private client team has many years’ experience of helping people to ensure that any gifts they give during their lifetime are tax-efficient, as well as ensuring that people take full advantage of their tax allowances.