Christmas is a time for giving
And even HMRC will give you their blessing at this time!
Christmas is rightly regarded as a time of giving and comes with an incentive from the taxman to give free of inheritance tax. With three themes, here are some ideas for lifetime giving at Christmas.
Immediate exemption for smaller gifts for individuals
There are a number of inheritance tax exemptions for small gifts made by one to another individual. They are:
- £250 Small Gift Exemption
This is intended to cover occasional and modest gifts to family and friends. Gifts of up to £250 in a tax year are exempt from inheritance tax.
As there is no limit to the number of individuals who can benefit from this exemption, it can be used as often as liked during a tax year.
- £3,000 Annual Exemption
Whereas the £250 small gifts exemption is on a “per donee” basis, the £3,000 annual exemption is on the “per donor” basis.
Gifts of up to £3,000 per annum, and a further £3,000 if the allowance of the previous tax year is unused, are exempt from inheritance tax.
Whilst the amount of £3,000 may not seem very much, if used regularly to fund premiums on life policies written in trust, a substantial sum can be gifted over a reasonable period.
- Marriage Exemption
Gifts in consideration of marriage are exempt as follows:
£5,000 for each parent
£2,500 for grandparent’s; and
£1,000 for all others.
The gift, which can be made in kind or in cash, has to be made on or before the date of marriage.
Potential exemption for larger gifts to individuals
Lifetime gifts to individuals are potentially exempt if the donor survives seven years from the date of the gift. Whilst this exemption is unlimited if the donor survives the seven years, it is important to remember that potentially exempt also means potentially taxable and that most lifetime transfers will, therefore, be potentially subject to inheritance tax.
If death occurs in this seven year period, the tax arising on death is tapered as follows:
Years after death: Reduction:
Not more than 3 years None
More than 3, not more than 4 years 20%
More than 4, not more than 5 years 40%
More than 5, not more than 6 years 60%
More than 6, not more than 7 years 80%
Fortunately, in the event of death within the seven years, it is normally the value at the time of gift which is subject to inheritance tax. Any subsequent increase in value falls outside this charge to inheritance tax. If however, the asset gifted in lifetime has fallen in value, the donee may be able to claim relief from inheritance tax for that reduction in value.
Lifetime giving by individuals with an anticipated life expectancy in excess of seven years is an incredibly effective way of passing wealth to the next generation. It is usual for the potential inheritance tax to be insured against with term assurance at a modest cost. However outright gifts usually mean that the donor loses control of the assets given away and consideration is usually given to the circumstances of the donee to receive wealth in this way.
Immediate exemption under the normal expenditure rule
One of the best inheritance tax exemptions, and possibly one of the least used, is the normal expenditure rule. This exemption allows individuals in their lifetime to make gifts limited only by the extent of their net after tax surplus income.
There are three conditions for the exemption to apply. It must be shown that the gift:
1. Was made as part of the normal expenditure of the person making the gift;
2. Was made out of his income; and
3. That the donor was left with sufficient income to maintain their usual standard of living.
Normal expenditure is taken to be habitual or typical, and is judged in the context of each donor. The amounts of the gifts do not have to be fixed nor do they have to be at the same time each year nor do they have to be to the same person. A single payment can qualify if it is part of a long term intention, if evidenced by a letter stating a future intention to make similar gifts.
Out of income is calculated on an annual basis and it is the net after tax income that should normally be considered. It is permissible to carry over income from one year to another, just so long as that income has not been accumulated into savings over a number of years.
It is necessary to show that after making the gifts, you had enough income to maintain your usual standard of living. Living on capital after making the gift will lose the exemption. This final test is possibly the hardest to meet and the one that calls for good record keeping.
In summary, arrangements such as payment of premiums for life assurance held in trust, funding stakeholder pensions for children and grandchildren, or funding trust funds over a number of years can take advantage of this valuable and unlimited exemption.
