Inheritance tax can often be a concern for individuals looking to pass on their assets to loved ones. Inheritance tax is a tax imposed on the estate (the total value of someone’s money and possessions) of a deceased person before the assets are distributed to beneficiaries.
The tax is calculated based on the value of the estate above a certain threshold, known as the inheritance tax threshold or nil-rate band. In the UK, inheritance tax is currently charged at 40% on the portion of an estate that exceeds the threshold.
Generally, if gifts are made within 7 years before someone dies, they may be subject to inheritance tax however, there are exemptions and allowances in place to ease this burden and these are considered below.
Gift Allowances and Exemptions
Understanding what constitutes a gift is crucial. A gift is not limited to cash; it can include household and personal goods, property, investments, and more. Therefore, understanding exemptions and allowances is essential to minimise potential inheritance tax liabilities.
Annual Exemption – £3,000
This allowance permits an individual to gift up to £3,000 in a tax year or £6,000 if the allowance for the previous year was not utilised, which would not be considered to be taxable. Importantly, this allowance can be split between multiple recipients but does not allow you to gift £3,000 multiple times in a year to different people which is sometimes an area that is misunderstood.
Small Gift Allowance of £250
This allowance enables individuals to make gifts of up to £250 per person as many times as desired within a tax year. However, this allowance cannot be combined with any other exemption for gifts to the same individual. Notably, gifts such as those given for Christmas or birthdays are exempt from inheritance tax.
Gifts for Weddings or Civil Partnerships
Individuals can give gifts in a tax year to someone who is getting married or entering into a civil partnership. The allowable amounts vary depending on the relationship: £5,000 for a child, £2,500 for a grandchild or great-grandchild, and £1,000 for any other person. This allowance can be combined with the annual exemption.
Gifts from Income Exemption
The gifts from income exemption allows individuals in the UK to make gifts out of their regular income without it being subject to inheritance tax. This exemption acknowledges that individuals may have surplus income they wish to distribute to family members or others without it being subject to the same taxation as gifts made from capital or savings.
Eligibility Criteria
To qualify for this exemption, certain criteria typically need to be met:
- Regular Gifting: The gifts must be made as part of a regular pattern, usually interpreted as being consistent and habitual. Occasional or irregular gifts may not qualify.
- Income Surplus: The gifts must be made out of the giver’s surplus income. This means that after accounting for all regular expenses and commitments, there must be income remaining available for gifting.
- Maintaining Standard of Living: It’s important that making these gifts does not negatively impact the giver’s standard of living. The giver should be able to maintain their accustomed lifestyle after making the gifts.
- Documented Evidence: Keeping clear records and documentation of both income and gifts is crucial to demonstrating eligibility for this exemption.
Benefits and Limitations
The gifts from income exemption offer several benefits:
- Tax Efficiency: By utilising this exemption, individuals can reduce their potential inheritance tax liability, allowing them to pass on more of their wealth to their chosen beneficiaries.
- Flexibility: Unlike some other forms of exemptions or allowances, there are typically fewer restrictions on who can receive gifts made under this exemption. This provides greater flexibility in estate planning.
However, there are also limitations:
- Complexity: Understanding the rules and requirements surrounding this exemption can be complex, and individuals may benefit from seeking professional advice to ensure compliance.
- Potential Changes: Tax laws and regulations can change over time, impacting the availability and conditions of exemptions like gifts from income. Staying informed about any updates or revisions is essential.
Should you wish to discuss any of the above in detail or explore personalised strategies, please do not hesitate to contact Emma Murray.