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June 22, 2016

Inheritance Tax Planning and Lifetime Gifts

Inheritance tax (IHT) is levied on chargeable transfers  that reduce the value of a taxpayer’s estate, both in their lifetime and on death.

The rates of IHT for transfers in excess of the nil rate band (£325,000 for 2016/17) and Main Residence Nil Rate Band is 20% for lifetime gifts and 40% on death.

By 2020/21 a married/civil partnered couple will be able to transfer assets worth £1m without triggering IHT.

For those whose assets exceed these limits, lifetime gifts can make a significant IHT saving.

Specific rules apply to the following types of transfers made in a person's lifetime:

  • Exempt Transfers,
  • Potentially Exempt Transfers, and
  • Chargeable Lifetime Transfers.

Exempt Transfers

The following transfers made during a person’s lifetime are exempt from IHT:

  • Transfers within the annual exemption of £3,000 per annum (any unused allowance can be rolled over to the next tax year up to a maximum of £6,000)
  • Transfers between spouses/civil partners (subject to restrictions for non-domiciled spouses)
  • Gifts to charities
  • Gifts to qualifying political parties
  • Gifts up to £250 per beneficiary per annum (e.g. Christmas/birthday presents)
  • Wedding gifts up to £5,000/£2,500/£1,000 for children/grand or great-grandchildren/others
  • Gifts out of regular income (see below)

‘Gifts out of regular income’ is an exemption sometimes overlooked by individuals looking to reduce their estate. For a transfer to be a ‘gift out of regular income’, it must be shown that it:

  • formed part of the transferor’s normal expenditure,
  • was made out of income (taking one year with another), and
  • left the transferor with enough income to maintain their normal standard of living.

Provided that the donor has sufficient surplus income, there is no cap as to the value of the gifts that can be made.

Given the potential of this exemption, it is important to have sufficient documentation to support any claims that a gift is out of regular income.

Potentially Exempt Transfers (PETs)

PETs include all chargeable transfers between individuals (and into a disabled person’s trust) that do not fall within the exemptions already mentioned.

As the name suggests, PETs have the potential to be completely exempt from IHT provided the donor survives for 7 years after making the gift.

If the donor dies within 7 years, IHT will be chargeable on the initial value of the ‘failed’ PET above the available nil rate band. Taper Relief may be available.

The donee will normally incur any liability to IHT.

Chargeable Lifetime Transfers (CLTs)

CLTs include transfers into trust during a person’s lifetime; for example, to establish a discretionary trust for children/grandchildren.

In contrast to PETs, CLTs are immediately chargeable to IHT, however a charge to IHT (at the lifetime rate of 20%) will only arise where the transfer (together with CLTs in the previous 7 years) exceeds the nil rate band.

CLTs will become chargeable to IHT if the donor dies within 7 years of gifting the asset. If the transfer was above the available nil rate band, IHT is payable at the full rate of 40%.

Credit for any previous IHT paid will be available and, like PETs, Taper Relief is available.

The donee will normally incur any liability to IHT.

Loans to Bare or Discretionary Trusts

Loans to trusts will not be deemed to be CLTs or PETs as the value of the loan remains within the estate.

Loan trusts will often use the advance to buy an investment bond. The growth from this investment will then accumulate to the trust, not the taxpayer’s estate.

This type of arrangement allows a taxpayer to receive a regular repayment stream from their loan, maintain control over their capital, and allows wealth to accrue to their intended recipient(s).

Timing of Gifts

The timing of different types of gifts should be carefully considered as part of the overall tax planning exercise.

For example, where gifts are being made both into trust (CLT) and directly to individuals (PET), it will normally be most tax effective for the CLT to be made before the PET, this is due to the way in which the trust's on going tax charges will be calculated.

Other Considerations

Commercial factors are important, for example; what is the purpose of the gift? do you want to retain some control over the gifted asset? are you happy to give away both the capital asset and any income derived from it?

In some cases it is possible to retain some/all of the income, however care is needed because anti-avoidance rules can apply to gifts where the donor retains an interest in the subject of the gift.

With any tax planning it is important to consider the wider tax implications for example; on-going IHT trust charges on exit/10 year anniversary, capital gains tax in relation to the disposal of assets, and income tax if the asset produces income.

If you have any queries with regards to Inheritance Tax, please contact Vikki Elliott at vikki.elliott@pd-taxconsultants.co.uk

Contact us today to discuss your tax requirements.
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