Christmas is a time of giving and invariably we tend to push the boat out when it comes to spoiling our family and friends with an extra special gift. For some, however, inheritance tax is and should be something they consider as the tax effects of making some gifts may not be properly understood.
Firstly, what is inheritance tax?
Essentially, it is a tax calculated based on the value of a person’s assets (their “estate”) when they die. It is called Inheritance Tax because essentially it will become payable when someone inherits from another’s estate. Sometimes, however, it is also payable by the recipient of a gift from someone else during their lifetime depending on the value of it and the value of other gifts made by the giver within 7 years of their death. The gift does not have to be monetary; it could be a Christmas gift of property, vehicles, artwork or jewellery.
So, what can you gift?
Simply, in any given tax year, a person is able to gift a cumulative total value of £3,000 to whoever they choose without any Inheritance Tax implications. They can also give as many small gifts up to £250 to as many different people as they like. These are known as small gift exemptions.
Have you heard of the seven-year rule?
If someone gifts over £3,000 in any one tax year, the seven-year rule will apply.
The giver will need to survive a period of seven years from the date of the gift for the value of the gift over and above £3,000 to be (largely) irrelevant for Inheritance Tax.
If the giver doesn’t survive seven years, the value of the gift over and above £3,000 will serve to reduce the tax-free allowance that could otherwise be applied to the value of the giver’s estate on their death (the Nil Rate Band). If the cumulative value of all of the gifts made within seven years before the giver’s death exceeds the Nil Rate Band then the recipient of some or all of the gifts may need to pay the Inheritance Tax attributable to their own gift or gifts. However, the tax payable may be reduced by taper relief if it has been more than three years since the date of the gift or gifts.
Can I make any exempt gifts?
Gifts to charities and some gifts for marriages or civil partnerships are not liable for inheritance tax, depending on how closely related you are to the newly weds. All gifts between spouses or civil partners are also exempt. Otherwise, all gifts are in some way or another chargeable to Inheritance Tax or at least a record of them should be made particularly if any future gifting is anticipated.
Is Inheritance Tax always a certainty?
No one can tell what the future holds and whether the giver of a gift will live more than seven years. Sticking within your annual allowance of £3,000 and making use of your small gift exemptions, however, are practical ways of ensuring that the recipient will not be faced with a liability in years to come provided the tax rules don’t change significantly in the meantime.
Generally speaking, for most people, gifting at Christmas is funded by saving for several months before the big day from excess income i.e. income that isn’t needed to maintain your own standard of living once all living costs are met. If you can demonstrate that this “formula” applies in your case then the value of the gifts (whatever that might be) could be exempt from Inheritance Tax.
So, what shall I do?
For most people, the tradition of making gifts at Christmas will not impact their Inheritance Tax position as the value of the gifts they make are within the £3,000 allowance. If the value of the gifts you make either at Christmas or at other times in the year exceed this amount, seek advice as to what impact this may have either on your own estate planning or that of the recipient.
Keep contemporaneous records of what you gift -even if the gifts are small in nature or value. These records could prove invaluable for your executors when deciphering your finances on your death and reporting to HM Revenue & Customs on any tax implications of your gifting.
Ultimately, it isn’t you that would be prosecuted for non-reporting, it’s your executors, who are often family and friends so ensure you have made things as easy for them as possible.
Please call us if you need any help or advice, 0800 84 94 101.