Families and individuals who ‘gift’ money to their children, grandchildren, friends or others need to be aware of the complex rules surrounding gifting and Inheritance Tax (IHT).
In England and Wales, IHT is levied at a rate of 40 per cent of an estate’s total value – but only if the estate exceeds the tax-free threshold or ‘nil rate band’ of £325,000, which each individual is entitled to.
One way of reducing IHT is to gift money to friends and family throughout your lifetime – but the rules governing IHT and gifting are notoriously complex and confusing.
Each individual is entitled to a £3,000 annual ‘gift allowance’ – meaning that gifts up to this amount will always be tax-free. However, anything above this threshold could attract IHT, depending on when the donor dies.
Simply put, there is a ‘seven-year rule’ in place governing gifts, which sees financial gifts to friends and family which are made in the same tax year and, taken together, are worth more than £3,000, only go IHT-free if the donor survives for seven years after passing on the money.
Each time an individual makes a gift, this will be classed as a ‘potentially exempt transfer’ for IHT purposes – which basically means that if the donor dies within seven years, the exemption will no longer apply.
More confusingly, if the individual making the gift receives any benefit from the assets given away then the seven year period will not commence from the date of the gift. There are different rules regarding gifts to trusts and, where very significant gifts are made, the amount of IHT incurred will differ depending on how many years have passed between the date the gift was made and the date the donor passed away.
Outside of potentially exempt transfers, however, individuals are also entitled to a number of other gift-based allowances which will never attract IHT, such as ‘small gifts’ made to an individual and totaling no more than £250 in any single tax year and ‘wedding gifts’ of up to £5,000 for a child, £2,500 for a grandchild or £1,000 for anyone else.
In any case, specialist advice is always crucial when it comes to complex IHT matters.