“…in this world nothing can be said to be certain, except death and taxes”. However, with careful lifetime tax planning, it is possible to reduce your potential inheritance tax (“IHT”) bill payable on death.
This note is not an exhaustive list of the life time tax planning tools available. Instead, it focuses on:
The Income Exemption is a valuable exemption which allows individuals to gift an unlimited amount during their lifetime which, provided the gift does not exceed the transferor’s surplus income, is immediately exempt from IHT.
This differs from a potentially exempt lifetime transfer (“PET”) as there is no need for the transferor to survive the gift by 7 years to gain the full benefit of the exemption. Furthermore, exempt gifts out of income do not eat into the transferor’s Nil Rate Band (“NRB”) leaving it fully intact so their NRB can be applied in its entirety against the transferor’s estate on death.
To receive the benefit of the Income Exemption, it important that the following qualifying conditions are met:
For the Income Exemption to apply, gifts must be made out of net income after tax. By way of example, income could include salary, commissions or rent received, dividend income from shares or interest paid on a bank account.
Gifts from income usually take the form of a monetary gift. However, HMRC will accept that a gift of another asset can qualify for the exemption provided that the asset was purchased specifically from the surplus income with the intention of making a gift.
Gifts made from capital (including capital content of a purchased life annuity or capital sums from the sales of investment) are not covered by the Income Exemption.
After making a gift out of income, the transferor must be left with enough income to maintain his usual standards of living for the Income Exemption to apply.
The Income Exemption will not usually apply if the transferor needs to resort to spending capital to meet their accustomed cost of living after gifts have been made out of income. The assessment of need and accustomed cost of living is fact specific and considers the transferors own standard of living, rather than the stand of living of the “average” person.
By way of example, after repaying their mortgage, grandparents could make comparable monthly payments to their grandchildren instead of mortgage payments. Payments to their grandchildren would not reduce the grandparents’ standard of living as their disposable income would remain the same.
What is “normal” for the purpose of the Income Exemption is not defined. However, it must be established that a gift out of income forms part of a settled pattern of gifting. The Income Exemption will rarely apply to one off gifts.
Ideally, there should be evidence of an intention to make regular gifts over a period of time. This will also protect the exempt status of the first gift in a series of gifts if it is evidentially clear that further gifts are intended.
HMRC guidance suggests that a reasonable time frame for establishing a pattern of gifting would normally be three to four years. HMRC does not a set period for regularity of gifts. Gifts could be monthly, quarterly or even every other year. The important thing is that an established pattern of gifting can be demonstrated.
A pattern of gifting must be established by proving a prior intention to make regular gifts, or evidence to show that there was a pattern e.g. a standing order to pay grandchildren’s school fees. Gifts do not need to be made to the same person, or be for the same amount.
The following lifetime wedding gift can be made exempt from inheritance tax:
Such gifts must be made on or shortly before the marriage to one or both parties. The exemption only becomes fully effective when the marriage takes place.
This news was posted on 30 June 2016.