Inheritance Gifts
Published / Last Updated on 13/05/2021
Inheritance Gifts
You may not have thought of what happens when people have gifted some of their possessions away and what happens when the person who has received that gift passes away.
Despite what you think you can do, you cannot just give your money or your assets away thinking you will avoid inheritance tax.
In addition, if you gift money away when you are likely to need care in older age, authorities could just claim it all back.
For Inheritance Tax purposes, you need to understand the basic rules on gifts because
- How much you gift
- How you gift
- Who or where you make the gift to
- How long ago you made the gift
- Whether you gift in life or on death
May give rise to a tax liability now or possibly in the future.
For more help with inheritance gifts and making them contact us.
1. Types of Gift - What Happens When I Make A Gift?
By giving away some of your possessions during your lifetime you could reduce the eventual Inheritance Tax bill on your estate.
Who Receives The Gift Is Important: Depending upon which person or organisation or group receives them affects any tax liability.
Gifts to Partner - In Life and Death:
- You need to be careful to gift to persons other than your husband or wife or civil partner. This is because transfers to a United Kingdom domiciled legal spouse or civil partner are exempt from Inheritance Tax anyway. So no impact would be made on the estate after a gift, you are merely postponing any tax liability to the second death.
Gifts to Other People - In Life and Death:
- Gift in Life - This is known as a potentially exempt transfer PETs. No tax is payable even if the nil rate allowance is exceeded and the gift is potentially exempt for 7 years. If death occurs within 7 years, taper relief may be applied to the value of the gift made.
- Gifts on Death - If you make a gift on death, if the total value of the estate is below the inheritance nil tax threshold (including any PETs within last 7 years) , then no tax is payable, if the estate exceeds the nil rate tax threshold then inheritance tax is payable on the excess above the threshold.
Gifts to Trusts:
- With the exception of absolute or bare trusts and disabled trusts, gifts to flexible trusts, interest in possession trusts and discretionary trusts are chargeable lifetime transfers and potentially taxable immediately.
Gifts to Charity - are free of Inheritance Tax
Gifts to Political Parties - are free of Inheritance Tax
Gifts to a Business - are chargeable lifetime transfers and potentially taxable immediately.
Contact us today for advice on the types of gift.
2. Gifts Accumulate
If you make gifts or transfer assets, the value accumulates and is noted for 7 years. If the total moves above the nil rate tax threshold, these will either be:
- Potentially Exempt Transfers: which would not immediately be taxable
- Chargeable Lifetime Transfers: which are potentially taxable immediately
Lifetime Transfer Cumulative Gifts:
When you make a chargeable lifetime transfer or gift, the value of the all chargeable gifts made in the last 7 years accumulate and if they exceed the nil rate tax threshold, tax is chargeable immediately on the gift that you make.
Potentially Exempt Transfers PETS:
These do not accumulate on day 1, but there value accumulates on death within 7 years.
3. Potentially Exempt Transfer
Some gifts or transfers are potentially exempt transfers (PETs) for Inheritance Tax purposes.
These potentially exempt gifts are normally gifts to
- Family and friends (not spouse or legal partner as already exempt)
- Other Individual people
- Disabled Trusts
- Absolute or bare trusts
They are called Potentially Exempt Transfers (PETS) as there is no immediate liability to tax.
Death after 7 years:
Potentially exempt transfers (PETs) are fully exempted and not subject to inheritance tax.
Death within 7 years:
Potentially exempt transfers (PETs) may be subject to inheritance tax subject to Taper Relief rules.
Other Trusts
On 22 March 2006 (Gordon Brown's Budget 2006) gifts to Accumulation & Maintenance Trusts and Interest In Possession Trusts are no longer treated as PETS and are deemed lifetime chargeable transfers.
4. 7 Year Taper Relief
A PET is a Potentially exempt transfer - PETs - What Happens After 7 Years?
It means that the gift is potentially exempt from being included in inheritance tax calculations and after 7 years the value of the gift made is fully outside the estate.
PETs - What happens if I die within 7 Years
If you die within 7 years, the full value of the gift is calculated as inside the estate.
Date order is important:
The value of the gifts accumulate towards the nil rate threshold in the order that they were made.
But, if the value of the potentially exempt transfers (PETs) made in the last 7 years, exceeds the value of the nil rate tax threshold, the value in excess of the threshold will qualify for taper relief.
Taper Relief - When does it apply?
This effectively reduces the amount of Inheritance Tax payable. Tax is attracted depending on the value of the transfer and the deceased persons cumulative total transfers.
- Gifts made upto 3 years before death do not qualify for any Taper Relief.
- Gifts made between 3 and 4 years before death are charged at 80% of the 40% flat rate.
- Gifts made between 4 and 5 years before death are charged at 60% of the 40% flat rate.
- Gifts made between 5 and 6 years before death are charged at 40% of the 40% flat rate.
- Gifts made between 6 and 7 years before death are charged at 20% of the 40% flat rate.
- Gifts made over 7 years before death fall outside the deceased persons estate.
IMPORTANT: Taper Relief only applies to gifts in excess of the IHT Nil Rate Band (currently £325,000.00).
- Example 1: A person makes a Potentially Exempt Transfer Gift of £400,000 to their children. They then die 7 years later: £400,000 is free of Inheritance Tax.
- Example 2: A person makes a Potentially Exempt Transfer Gift of £400,000 to their children. They then die 2 years later: £325,000.00 is within the IHT allowance meaning no IHT, £75,000 receives no Taper Relief as death within 3 years so taxed at 40% i.e. 100% of the excess £75,000 is taxable at 40%.
- Example 3: A person makes a Potentially Exempt Transfer Gift of £400,000 to their children. They then die 3.5 years later: £325,000.00 is within the IHT allowance meaning no IHT, £75,000 is subject to Taper Relief meaning that 80% of the Tax due on the excess £75,000 is payable.
Common Mistake
A common mistake made by people and their advisers is that you apply taper relief to the gift to adjust its value for inheritance tax purposes before accumulating the total value of the estate. This is incorrect.
The correct method is to accumulate the unadjusted values of any PETs and if they then cross the nil rate tax threshold, taper relief is applied to the most recent gifts, not the oldest gifts.
5. Lifetime Taxable Gifts
Gifts or Transfer of assets that you make during life are known as lifetime gifts or transfers.
Many lifetime transfers are exempt or potentially exempt transfers (PETs). The rest are known as Chargeable lifetime transfers.
Chargeable Lifetime Transfers: are
- Gifts to Discretionary Trusts
- Gifts to Flexible or Interest in Possession Trusts
- Gifts to a Business
When is tax payable: In Life
If the cumulative value of chargeable lifetime gifts in the last 7 years exceeds the nil rate threshold then inheritance tax is payable at 20% immediately.
If you then live for 7 years: no further tax is payable
If you die within 7 years: if the cumulative value of the gift and the estate, and the previous gifts in 7 years exceeds the nil rate threshold then inheritance tax is payable at a further rate of 20% on those gifts or transfers that have already been taxed and 40% on any excess not yet taxed.
What happens if the estate is below the threshold on death but had paid taxes? Can tax paid be reclaimed? The answer is no.
6. Gift with Reservation
If you make a gift or transfer an asset to the ownership of another and still continue to benefit from is known as a gift with reservation.
Examples of a Gift with reservation:
- Gifting or transferring ownership of property but continuing to live their or use it
- Gifting money, but still getting interest
- Gifting an antique but still having it in your home on display
Inheritance Tax Treatment of a Gift with Reservation
In simple terms, HM revenue and Customs will treat the asset as if it has never been gifted and it will be taxed on death as part of the estate accordingly.
If you thought the gift was a chargeable lifetime transfer at the original date of transfer and you paid inheritance tax on it at the time and then subsequently it were found to be a gift with reservation and fully chargeable to tax on death also, HM Revenue and Customs will generally not double charge tax. They will also allow a credit for tax paid.
7. What Happens If I Make A Gift To Someone And They Die?
If you make a chargeable transfer to someone (where tax has been paid) and they die within five years of receiving it, credit will be given for part of the Inheritance Tax paid when you made the transfer.
The amount of credit will depend on how many years the person survived after you had made the transfer, as follows:
Time Between Transfer And Death Credit Given On The Tax Already Paid
- 1 year 100%
- 2 years 80%
- 3 years 60%
- 4 years 40%
- 5 years 20%
For example, if you had made a chargeable transfer and the tax was £100, if the person to whom you made the transfer died after 3 years, a credit of £60 would be allowed (60%).
Request expert inheritance tax advice.
8. What is Pre-Owned Asset Tax POAT?
Basically, if you continue to derive a benefit from an asset that you have gifted or transferred to another you may be subject pre-owned asset taxes POAT.
How Much Pre-Owned Assets Tax (POAT) Paid?
An annual cash value for the benefit that you derive from the pre-owned asset is worked out. Much in the same way as benefits in kind for employees such as a company car.
This annual cash value benefit is classed as taxable income and subject to normal income tax rules.
What Is Exempt From Pre Owned Assets Tax POAT?
They are mainly land ownership related assets:
- Transfers to your spouse or civil partner
- Transfers to connected people e.g. family if sold at full market value
- Assets owned and disposed of before March 1986
- Assets that will be caught by Gift with Reservation rules
- Assets where you have transferred some ownership such as a Home Reversion Equity Release Scheme
How to avoid pre-owned assets tax POAT
Broadly, there are only 2 ways to avoid pre-owned assets tax on assets that you may have already transferred ownership away from you:
- Unravel the arrangements that you made for the transfer of ownership
- Elect to have the asset included in your estate in full for inheritance tax purposes on death
- Give up your right of enjoyment of the asset, which may not work if it is your home
Decision to unravel
It may be after weighing up the income tax charges for POAT versus full inheritance tax charges on death, that you decide it is more economical to keep paying POAT. We suggest you need advice in this regard.
Problems with trusts
If you have already gifted assets into trusts you may have difficulty unravelling these and therefore may have to remain with a pre-owned asset tax levy.