HMRC’S DEFINITION OF INHERITANCE TAX
“Inheritance Tax is a tax on the estate (the property, money and possessions) of someone who has died”.
WHAT IS A ‘GIFT’
The following are considered ‘gifts’ which could be subject to Inheritance Tax:
- Money
- Household goods such as furniture and antiques
- Jewellery
- Property (a house, land or buildings)
- Stocks and shares listed on the London Stock Exchange
- Unlisted shares you held for less than 2 years before death
A gift can also include passing things to your children at a discount. For example, if you sell a house to your child for £100k and the property was valued at £150k at the date of sale, HMRC will deem the £50k you did not receive to be a gift to your child. This £50k could be subject to Inheritance Tax depending on when the gift was made.
WHAT GIFTS ARE FULLY EXEMPT FROM INHERITANCE TAX?
Gifts to the following recipients are free from inheritance tax:
- The Inter-Spousal Transfer – any gift made between spouses/civil partners provided you both permanently live in the UK and are legally married/civil partnership to each other.
- Any gifts made to charity (including museums)
- Any gifts made to political parties
ALLOWANCES AVAILABLE TO MAKE TAX-FREE GIFTS
ANNUAL EXEMPTION
Every tax year you can give away a total of £3,000 in gifts without them being added to the value of your estate, making the first £3,000 of gifts tax-free. You can give £3,000 to one person, or you can make smaller gifts totalling £3,000 to several people.
You can carry forward any unused annual exemption to the following tax year only, but the current year allowance must be used first before applying the brought forward annual allowance from the year.
For example:
2024/25 Gifts made £1,000
Annual Exemption C/F to 2025/26 £2,000 (£3,000 – £1,000 gift made)
2025/26 Gifts made £4,000
Less: Annual Exemption 2025/26 £3,000 (Full allowance claimed)
Less: B/F Annual Exemption 2024/25 £1,000 (£1,000 wasted)
This example demonstrates that you have lost £1,000 annual exemption from 2024/25 as this cannot be carried forward beyond 1 tax year. The 2025/26 Annual Exemption was used first, meaning no exemption is left to carry forward to 2026/27.
SMALL GIFT ALLOWANCE
You can give as many small gifts of up to £250 per person as you want per tax year provided that you have not used any other allowance on the same person (such as Annual Allowance, or a wedding gift).
However, please note Birthday and Christmas presents made from your surplus regular income (salary) are exempt from Inheritance Tax.
GIFTS FOR WEDDINGS/CIVIL PARTNERSHIPS
Each tax year you can make a tax-free gift to someone who is getting married (or starting a civil partnership). Depending on the relationship of the recipient to you, you can make the following gift which will be exempt from inheritance tax:
- £5,000 to a child (or step-child)
- £2,500 to a grand-child or great-grandchild (including steps)
- £1,000 to any other person
You can give the wedding gift allowance beside any other allowance except the small gift allowance, meaning you could give your child £8,000 in the year they get married (£5,000 wedding gift and £3,000 annual exemption).
REGULAR PAYMENTS (GIFTS OUT OF SURPLUS INCOME)
You can make regular payments to another person, there is no maximum to this allowance, but the regular payments must satisfy the following criteria:
- You can afford the payments after meeting your usual living costs
- You make these regular payments from monthly income
Common examples of regular payments which are allowable include:
- Paying rent on behalf of your child whilst at university
- Paying for education or extra-curricular activities (such as dance classes)
- Paying the utility bills for an elderly relative.
It is important to note that this expenditure must be out of surplus income, and not savings.
THE 7-YEAR RULE
Potentially Exempt Transfers (PETS) are gifts made which will become chargeable to Inheritance Tax if they ‘fail’. ‘Fail’ means you do not survive 7 years from making the gift. If you survive 7 years from making the gift, the transfer is exempt and no inheritance tax will be charged on the gift.
If you die between 3 – 7 years of the date you made the gift, then Taper Relief applies, reducing the rate of inheritance tax payable for each year.
The rates of Inheritance Tax payable are:
|
YEARS BETWEEN GIFT AND DEATH |
RATE OF TAX ON THE GIFT |
|
UP TO 3 YEARS |
40% |
|
3 TO 4 YEARS |
24% |
|
4 TO 5 YEARS |
16% |
|
5 TO 6 YEARS |
8% |
| 7 OR MORE |
0% |
Taper will only be relevant where the gift exceeds any nil rate band you may have.
GIFTS YOU STILL BENEFIT FROM (GIFTS WITH RESERVED BENEFIT)
If you gift an asset to someone but you still benefit from it, this is called a ‘gift with reservation’. The value of this gift will still be included in the value of your estate.
Gifts with reservation include:
- Giving your home away to a relative but you still live there
- Giving away a second home but you use it for your holidays
- Giving an antique away but it remains in your house, such as a painting or piano
To avoid these gifts being subject to Inheritance Tax, you must pay the person you made the gift to the market rent to use the asset. The market value must be regularly re-assessed to ensure that you are not benefitting from the asset. It is important to note that there could be income tax implications for the recipient such as reporting rental income.
KEEP RECORDS OF GIFTS MADE
On your death, it is the legal responsibility of your Executors to ensure that the correct Inheritance Tax has been paid on your Estate.
When making gifts, you should make a record of all gifts made with the following information so that the gifts can be treated correctly:
- What gift you made, and who the recipient was
- The value of the gift
- When you gave it
You may think that this is not important, and have the view ‘Why should inheritance tax be paid on the gifts I made in my lifetime when you have paid tax all of your life’, well, your Executors are legally responsible for declaring the gifts made, and if false declarations are made, HMRC can pursue them personally.
Should the executors incorrectly calculate the inheritance tax payable, HMRC can demand the underpaid tax from the Executor(s) personal funds if there are not enough funds in the estate (if the executors have already distributed all the assets, for example).
This means if you do not correctly document the gifts made in your lifetime, you are risking subjecting your executors (often loved ones) at worst, to imprisonment for tax fraud if they cannot pay the additional tax required.
If would like to discuss any of the above or anything else, please contact 01228 534371 or advice@saint.co.uk
This article is to provide information on the inheritance tax implications on gifts and should not be construed as financial advice. Separate tax advice should be sought for your specific situation.
If you know anyone who may benefit from our newsletters and updates, please feel free to forward this blog or ask them to opt in to our mailing list.
