Lifetime Gifts and Inheritance Tax Taper Relief
It is not uncommon for people to decide to give away cash or assets during their lifetime in the hope of saving inheritance tax when they die. Often, these will be gifts to their children or other family members or into trusts for them.
Inheritance Tax and Taper Relief
Many people know that the value of such gifts will only fall out of their estate for inheritance tax purposes if they live seven years after making the gift. A common misconception, however, is that taper relief will mean that the value of the gift will decrease on a sliding scale between the third and seventh years meaning that tax will be saved from third year onwards. In fact, this is rarely true. Taper relief is only actually of benefit if the value of the lifetime gifts exceeds the inheritance tax threshold. This is presently £325,000 and most of us cannot afford to give away that much.
Seven Year Survivorship Rule & Applying Taper Relief
There are certain inheritance tax allowances which are outside the scope of this article (such as those for small gifts and gifts out of income) but the seven-year survivorship rule applies to most gifts outside of those exemptions. This is essentially to stop people giving everything away just before they die to avoid inheritance tax. To understand how taper relief applies, there are two key points. The first is the question of what taper relief actually reduces. The second is how the inheritance tax calculation works when you die.
On the first point, taper relief does not reduce the value of a gift between the third and seventh years, it reduces the rate of tax on the gift on a sliding scale between years three and seven.
In relation to the calculation of inheritance tax when you die, the first part of each estate (the nil rate band) is free of tax (or to be more precise, and speak as a solicitor, that part of the estate is taxed at 0%). As mentioned above, the nil rate band is presently £325,000. The key consideration for taper relief is that any gifts that were made within the last seven years will use up the nil rate band first, before any balance of the nil rate band is set against the value of the estate that the person still has when they die. If the lifetime gifts come to less than £325,000, because they will come within the nil rate band, the rate of tax on them will be 0% and although taper relief theoretically applies between years three and seven, it is a reduction of 0%, and therefore of no benefit. The value of the gifts themselves in the calculation will not be reduced.
To illustrate the point, consider two tax payers, one makes a gift to £200,000 and the other makes a gift of £400,000 and they each die six years later.
For the person who makes the £200,000 gift, because the £200,000 is less than the nil rate band, the rate of tax on it will be 0% and taper relief will therefore be of no benefit. The gift will still use up £200,000 of their nil rate band.
For the person who makes the £400,000 gift, however, because the gift exceeds £325,000, there will be some tax to pay on it (inheritance tax will be payable on the £75,000 by which it exceeds the nil rate band). In this case, therefore, there is some tax on the gift for taper relief to reduce and the relief will be of some real benefit.
In very basic terms, therefore, unless you make gifts exceeding £325,000 it is all or nothing. If you survive seven years, the gifts will drop out of your estate for inheritance tax purposes and there will be some tax benefit. If you die within seven years, the whole value of the gifts will still be included in the tax calculation when you die.
Another important point to bear in mind when making lifetime gifts is that the fact that the gifts will use up the first part of your nil rate band if you die within seven years will mean that there will be less nil rate band to set against the estate that you own when you die, which can increase the inheritance tax payable on your estate. This is particularly important if the beneficiaries you leave your estate to through your Will are not the same as the recipients of the lifetime gifts. If you die within seven years of making the gifts, the beneficiaries of your estate can end up bearing more inheritance tax because you have given assets away to other people. It is worth considering whether the gifts should be made conditional upon the recipients agreeing to reimburse your estate for any additional inheritance tax should you die within the seven years.
The tax consequences of making gifts can be complicated and it is always a good idea to take advice on your specific circumstances.
For further advice contact Mark Jones at email@example.com or on 01423 502211.
Further advice please contact Mark Jones on 01423 502211 or firstname.lastname@example.org