Inheritance tax gifts are gifts made during a person’s lifetime that may be subject to inheritance tax if they were made fewer than 7 years before the donor’s death.
For many, inheritance tax is a growing concern and so they may choose to make gifts now to reduce inheritance tax in the future. This article considers the inheritance tax implications of gifting assets (excluding property) to the next generation. For more information, please read our article on gifting property to children.
How much can you gift tax free?
Cash 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, such a gift will be a ‘Potentially Exempt Transfer’ (PET). Accordingly, as long as the donor survives seven years from the date of the gift, it will not be subject to IHT on their death. If the donor survives at least three years, taper relief may apply to reduce any IHT charge arising.
Care is needed when making gifts to minor children or if the donor is going to retain some form of benefit from the gifted asset, as this could make the gift ineffective for IHT purposes or give rise to additional tax charges.
Income arising from assets gifted to minor children by their parents can be assessed to income tax on the parent where the income exceeds £100 in a tax year. This is to avoid transferring income from the parent to the child to utilise their tax-free allowances.
Gifts of personal belongings
Most personal belongings are classed as chattels and they are defined as tangible or moveable property. There are two types of chattels: cheap chattels and wasting chattels. A cheap chattel is any chattel with a predictable useful life of more than 50 years (such as paintings and antiques), whereas a wasting chattel is one with a predictable useful life not exceeding 50 years (such as racehorses and wine).
The main problem with gifting assets is that a CGT charge is likely to arise where the asset has increased in value, as the gift will be treated as a deemed disposal at market value for CGT purposes.
There are specific rules regarding the calculation of the CGT charge for cheap chattels, and in some cases this can mean that a disposal is exempt from CGT. As a result, it may be tax efficient to make gifts of such assets, such as antiques, in order to reduce an individual’s chargeable estate for IHT purposes.
For assets that have fallen in value since the date of acquisition, the gift will give rise to a capital loss. Usually, losses can be offset against any capital gains arising in the current tax year or carried forward to future tax years. However, where losses arise on assets gifted to a connected person (such as a relative), the use of the loss will be restricted.
Wasting chattels and some other specific assets are exempt for CGT purposes and can generally be given away with no immediate tax charge arising.
From an IHT perspective, a gift of any of these types of assets would still be a PET and would not give rise to an IHT charge, as long as the donor survives seven years from the date of the gift.
Gifts from surplus income
This is a very valuable IHT relief, as it immediately exempts from IHT any gifts made from surplus income without the requirement to wait the usual seven year period. The rationale for this exemption is that IHT is a tax on capital, which should not extend to gifts of income. There is no limit on the amount that can be given away, other than it must not exceed the donor’s surplus income.
For the relief to apply, the donor must be left with sufficient income to maintain their usual standard of living after the gifts are made, and it must form part of their normal expenditure. Normal in this context means habitual or recurring and so it is important that the donor establishes a regular pattern of gifts, or at least an intention to make regular gifts. This could include setting up a standing order, paying grandchildren’s school fees or paying regular premiums on a life policy. One-off gifts or gifts for a special purpose will not qualify. HM Revenue & Customs (HMRC) is, increasingly, investigating these claims, and so it is important that good record keeping is maintained by the donor to demonstrate that the expenditure meets the relevant conditions to qualify for the exemption.
Gifts and inheritance tax
For a gift to be effective from an IHT perspective, the donor must not retain any benefit from the asset, otherwise the asset will form part of the donor’s estate for IHT purposes, regardless of the legal ownership. These anti-avoidance provisions were introduced to prevent a taxpayer from reducing the value of their estate for IHT purposes, whilst continuing to benefit from the assets given away. This could include situations such as a boat or caravan passed on to children, where the donor continues to use it for holidays, or where a picture that has ostensibly been given away remains displayed in the donor’s home.
The anti-avoidance rules extend even further to prevent the donor from benefiting from assets which they once owned, or which they assisted others to acquire. In this instance, an annual income tax charge can arise under the ’pre-owned asset tax’ rules. The legislation is complex, and we recommend seeking professional advice if any benefit is to be retained either directly or indirectly by the donor.
Inheritance tax considerations
Gifting chattels and cash will help to reduce a taxpayer’s estate for IHT purposes, but careful consideration of the tax consequences is required to ensure the gift is both effective for IHT purposes and does not give rise to any unforeseen tax charges. It is important the donor does not retain any benefit from the gifted assets, nor assists others to purchase assets which the donor will benefit from.
For taxpayers with significant income, gifts out of surplus income can be a very valuable relief, due to the immediate exemption from IHT.
Although gifting assets will reduce the value of the donor’s estate for IHT purposes, it is important the donor considers their future capital and income requirements and retains sufficient assets to enable them to live comfortably for the remainder of their life. Any remaining IHT exposure could be sheltered by an appropriate insurance policy.
When considering making gifts to reduce inheritance tax, we recommend that specialist tax and legal advice is sought regarding individual circumstances before any action is taken.
If you would like to discuss any of the matters raised here, please contact your usual Saffery contact, or speak to Suzanne Wasson.
Making Gifts to Reduce Inheritance Tax – Additional Reading:
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