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Lifetime gifts and Inheritance Tax – two common myths

Inheritance tax and lifetime gifts

As clients get older it is not uncommon for them to consider giving away assets while they are still living in the hope of saving Inheritance Tax and to benefit their loved ones immediately. Often, however, they can misunderstand the tax treatment of such gifts.

People often know the basic starting point that that the value of a gift will only drop out of your estate for Inheritance Tax purposes if you live for seven years after making it. If this was not the case people could avoid Inheritance Tax simply by giving everything away at the last moment.

In this article, we explore two of the common misconceptions people have surrounding lifetime gifts.

1. 'The value of the gift will decrease on a sliding scale between the third and seventh years so that they will get some benefit so long as they live for three years.'

There is a sliding scale between the third and seventh years but this reduces the rate of tax payable on the gift and not the value of the gift itself. The full value of the gift remains in your estate for the whole seven years.

The point here is that each estate has a basic Inheritance Tax allowance of £325,000. So, if you have made gifts during your lifetime; which part of the taxable "pot" gets the benefit of this allowance if taken chronologically?

  • You make a gift of ¬£100,000 and die four years later.
  • There would be no tax on that gift because it comes within the ¬£325,000 Inheritance Tax threshold.
  • Therefore, the percentage reduction under the sliding scale will be of no value (because there will be no tax on the gift to reduce).
  • The gift will still use up ¬£100,000 of your tax allowance.

This is a longwinded way of saying that unless you make a gift of more than £325,000, there will be no Inheritance Tax benefit unless you live for the full seven years.

2. 'The worst that can happen is that the gift will have no benefit for Inheritance Tax purposes.'

There can also be unintended consequences with regard to which beneficiaries bear the tax on your estate. When allocating your basic Inheritance Tax allowance of £325,000 between the different parts of the "pot", any lifetime gifts that were made within the last seven years will be taken first.

  • You have three children and your estate is ¬£975,000.
  • If you do not make any lifetime gifts and divide the estate equally between your three children when you die. The ¬£325,000 allowance will be set against the whole of your estate and your three children will benefit equally from it.

If, however, you made a lifetime gift of £325,000 to one of your children and died within seven years leaving the rest of your estate equally to your other two children through your Will.

  • The ¬£325,000 lifetime gift would use up the whole of your Inheritance Tax allowance (because it came first) leaving no Inheritance Tax allowance to be set against your remaining estate.
  • The child who got the lifetime gift would get the gift tax free.
  • However, all of the tax on your estate would end up being borne by your other two children.

When making lifetime gifts it is therefore important to be aware of the possible knock on effect on who would bear the Inheritance Tax on your estate and to allow for this. For example, you can make the lifetime gift conditional upon the person who receives it agreeing to reimburse your estate for any additional tax that results from it.

Other common pitfalls

These are just two of the common misconceptions and there are other points that clients often do not appreciate. For example, they are not always aware that if you make a gift during your lifetime you have got to give up any future benefit from the asset you are giving away. For example, if you give away a valuable painting you cannot then keep it on your wall.

Clients also often assume that giving assets away will protect them from being claimed by the Local Authority in relation to nursing home fees which, again, is not necessarily the case. There are certain provisions under which a Local Authority can challenge a lifetime gift if they can show that the intention behind it was to avoid the asset being included in means testing for care fees. In the worst scenario you could give away the asset and then find that the Local Authority would not pay your care fees.

The basic point is that making gifts during your lifetime is not as straightforward as might initially seem to be the case and you should take proper advice before doing so.

If you are thinking of giving assets away contact Mark Jones on 01423 502211 for further advice before doing so.

Mark Jones - Wills & Probate Solicitor - HarrogateThis article was written by Mark Jones. Mark is a Partner in our Personal Law Department and is based in Harrogate.

Mark specialises in the creation and administration of trusts, tax planning and wills as well as probate work, particularly those where the family has fallen out and contentious issues have arisen.

You can contact Mark on 01423 502211 or ku.oc1716776631.fcl@1716776631senoj1716776631.kram1716776631

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