Gifts and Inheritance Tax: don’t fall foul of the rules!

The number of people being charged Inheritance Tax on gifts has been rising steadily in recent years.

The Financial Times reports that, after a Freedom of Information request, HMRC revealed that growing numbers of estates have become liable for IHT on gifts. In 2015/16 a total of 873 estates were liable. The following year, that number grew to 920 and then reached 993 for 2017/18. The total tax charged rose from £135m in 2015/16 to £156m in 2016/17 and then £197m in 2017/18.

Inheritance Tax is charged on estates worth £325,000 or more. This threshold has remained static since 2009, meaning a growing number of estates are getting caught in the IHT net.

If you have done any estate planning, you may be aware of the rules that cover gifts and Inheritance Tax. We’ve covered these rules in some detail in our post, “What are the rules for IHT on gifts?”. In brief, if you make a gift to someone and you live for another 7 years, that gift will normally become exempt from Inheritance Tax. However, the Telegraph reports that the taxman is raking in millions in IHT from ‘gifts gone wrong’.

A quick recap on gifts and Inheritance Tax

If your estate is worth over £325,000, Inheritance Tax at 40% is normally payable on anything over that amount. If you are married or in a civil partnership, you can pass on the whole of your estate to your partner without them having to pay IHT. Importantly, you can also pass on your £325,000 tax-free allowance. This means that, when you pass on the combined estate, you have a tax-free allowance of £650,000 for IHT. In addition, if you pass on the family home to a direct descendent, you can qualify for an additional £175,000 allowance. This is known as the ‘main residence nil-rate band’. We will cover this in more detail in a future blog post.

Gifts, therefore, can be useful if your estate is likely to be worth more than your combined tax-free allowances. Under the current rules, you can reduce your IHT bill by giving away assets. The amount of tax you pay depends on how long you live for after making the gift. These are the IHT rates that become payable, depending on how long you live after gifting an asset:

• 0-3 years: 40% (i.e. the standard rate of IHT)
• 3-4 years: 32%
• 4-5 years: 24%
• 5-6 years: 16%
• 6-7 years: 8%
• 7+ years: 0%

What are ‘gifts gone wrong’? 

If an asset is to be classified as a gift by the taxman, you are not allowed to have any future benefit from that gift. This is because of rules governing ‘gifts with reservation of benefit’ – i.e. gifts that you still benefit from.

The most common example of a gift with reservation of benefit is a family home. People will often ‘gift’ the property to their children, but then continue to live in it. If they then continue to live in the property without paying rent, the home is considered a ‘gift with reservation of benefit’. This means that it will not become exempt from IHT, even after seven years.

There are ways of avoiding this ‘gift gone wrong’ situation, but you need to make sure your estate planning doesn’t land you with even bigger bills. For example, if you gift your home to a child, it will become exempt from IHT if you then pay market rent for staying at the property. However, you then have to pay the rent until you died, the property was sold or you needed to go into long-term care. In addition, your child would have to pay Income Tax on the rental income. If the property grew significantly in value, they could also face a large CGT bill when they sold it.

How to get gifts and Inheritance Tax right

Currently, the taxman is looking closely at individual estates and checking that gifts comply with the rules. Between 2018 and 2019, families ended up paying £111 million in IHT that they weren’t expecting to – all because of the ‘gift with reservation’ rules.

Inheritance Tax on gifts – it’s time to plan

Given such an outlook, it’s more important that ever that you start your Inheritance Tax planning as soon as possible. It’s also essential you get good advice. For example, if you gift certain assets during your lifetime, they can be excluded from IHT. The catch is that you have to live for at least seven years afterwards. Other gifts can be made tax-free as well, including gifts to spouses. However, you really must get advice that’s tailored to your overall financial situation.

Inheritance Tax can be complex, so it’s little wonder that a growing number of beneficiaries are paying the tax on gifts. It’s highly likely that a good number of people whose estates were subject to IHT were unaware of the allowances and exemptions open to them.

So, if you want to avoid making gifts to family and friends that could land them with an IHT bill a few years down the line, get in touch. Our Inheritance Tax specialists would be very happy to advise you.