Much has been made this week of the news that David Cameron was gifted £200,000 by his mother in a move to reduce her anticipated inheritance. However, lifetime gifting is one of several legitimate tax planning measures available when reviewing your Inheritance Tax position.
What is Inheritance Tax?
Inheritance Tax is a tax charged against the value of your assets upon death. Currently every individual is entitled to a nil rate band of £325,000 - that is, the first £325,000 of your assets will be taxed at 0%. Everything above that threshold, subject to some exceptions and exemptions, is taxed at 40%.
Exemptions on Death
The key exemption for married couples is the Spouse Exemption. There is no Inheritance Tax payable on assets left to a spouse. Where a married couple leaves everything to each other there will be no tax to pay in the first instance. The surviving spouse will then acquire the predeceased spouse’s nil rate band and will effectively have two. The end result is currently on the second death £650,000 will be taxed at nil and anything over is taxed at 40%.
There are further exempt beneficiaries including Charities, some national institutions such as museums, universities and the National Trust and UK Political Parties.
There are other exemptions available on death for specific assets, namely Agricultural Property Relief and Business Property Relief. For more information on either of these reliefs please contact a member of our team.
Mrs Cameron (senior) made a lifetime gift of £200,000 to reduce the size of her estate on death. This is a legitimate Inheritance Tax planning measure and is subject to the Seven-Year Rule.
The Seven-Year Rule
Under the Seven-Year rule any gift made to an individual is exempt from Inheritance Tax provided the Donor lives for seven years after making the gift. This sort of gift is called a Potentially Exempt Transfer because it will fail to be exempt from Inheritance Tax if the Donor does not live for seven years.
In the event the donor does not survive seven years from making the gift, whilst the gift is still valid, the value of the gift will be added to the value of the Donor’s estate in order to calculate the Inheritance Tax due. If the value of the gift exceeds the Nil Rate Band, Inheritance Tax will need to be paid on its value, either by the person who receives the gift or the representatives of the estate.
Every individual has an annual exemption of £3,000. You can therefore give away up to £3,000 per year and the gift will not be added with your estate. It is possible to roll forward an unused annual exemption for one year, thereby giving £6,000 if you made no gifts the previous year.
Certain lifetime gifts are exempt from Inheritance Tax because of the type of gift or reason that you are making it.
Wedding gifts/civil partnership ceremony gifts are exempt from Inheritance Tax, subject to certain limits:
- Parents can each give cash or gifts worth £5,000
- Grandparents and great grandparents can give cash or gifts worth £2,500
- Anyone else can give cash of gifts worth £1,000.
The gift must be made, or be promised to the bride or groom, on or shortly before the date of the wedding or civil partnership.
Individuals can make as many small gifts of £250 as they like in each tax year. However, this does not permit repeated gifts to the same individual in one year and if you gift an amount greater than £250 the exemption is lost for the entire sum.
Regular Gifts out of Surplus Income
Any regular gifts you make out of your after-tax income, not including capital, are exempt from Inheritance Tax provided that after the gift you still have enough income to maintain your normal standard of living.
The gifts must be regular and can include monthly or quarterly payments to an individual, perhaps towards a mortgage, or regular premiums on a life policy. Where you intend to make gifts from surplus income it is helpful to complete a schedule demonstrating your monthly income and outgoings to demonstrate the amount of surplus income available.
There is no requirement to report gifting from surplus income during your lifetime, although your executors will be obliged to demonstrate that the income was surplus in order to claim that relief upon your death.
Changes to the Nil Rate Band
From 2017 the government will begin to implement a new ‘Transferable Main Residence Allowance’. Where a qualifying residential interest is closely inherited i.e. by children, the estate will benefit from the Transferable Main Residence Allowance in addition to the Nil Rate Band.
The Transferable Main Residence Allowance (TMRA) will be £100,000 in the tax year 2017 to 2018, rising £25,000 per year thereafter until it reaches £175,000 in 2021.
It will therefore be possible in 2021 for a qualifying individual to have £500,000 taxed at Nil, and for a married couple jointly to have £1 million.
However the TMRA will be lost if an estate is too large; the TMRA will be reduced by £1 for every £2 the estate exceeds the threshold of £2 million in 2020 to 2021. From 2021 the £2 million threshold will rise in line with the Consumer Price Index.
If you would like to review your Inheritance Tax position in respect of lifetime planning or ensuring your Will is tax efficient, contact a member of our Wills and Probate Team on 01279 755777.