There are many advantages to good tax planning such as passing on wealth to the next generation and being able to see for yourself how it can positively affect their lives during your lifetime. This blog looks at ways to utilise the inheritance tax exemptions and reliefs available to every person domiciled in the UK, in order to mitigate a potential inheritance tax (IHT) liability for their estate on death.
The inheritance rules can be very complicated; however, I have outlined some of the steps that can be taken to ensure that your estate is not eroded by IHT:
1. Gifts to spouse (s.18 Inheritance Tax Act 1984 (IHTA)) / Gifts to Charity
You are able to make a gift to your spouse (as long as they are domiciled in the UK) or to a registered charity and the gift will be automatically exempt from IHT. This means that you do not have to survive 7 years from the date of the gift in order for it to be effective for tax planning purposes.
2. Annual £3,000 exemption (s.19 IHTA)
During your lifetime, the first £3,000 of any gifts made in any one tax year can be made without any IHT consequences. In addition, if your exemption from the previous tax year was unused or only partly used, you can bring forward the unused amount and add it to the current year’s exemption.
Andrew makes a gift of £5,000 to Katie in the 2018/19 tax year. Andrew is able to use his 2018/19 exemption of £3,000 against the gift. If Andrew did not make any gifts in the 2017/18 year, he would be able to bring forward that year’s exemption and the entire £5,000 gift would be exempt from IHT. If the gift were for £7,000 then only the last £1,000 would be taxable on these facts.
3. Small gift exemption (s.20 IHTA)
Outright gifts of up to £250 to any number of individuals made in any one tax year are exempt. This means that a person can give up to £250 to as many different individuals as he or she pleases in a given tax year and those gifts would all be exempt from IHT. You cannot give lots of small gifts to the same person however, and expect them to be tax free!
4. Normal expenditure out of excess income (s.21 IHTA)
This can be a valuable exemption to mitigate IHT and can be a valuable way for parents and grandparents to gift excess income to beneficiaries. If a gift falls under this definition, then for IHT purposes, it is irrelevant whether or not the person making the gift survives for 7 years as the gift will be exempt. For the exemption to apply, it must be shown that the gifts were:
(a) made as part of the normal expenditure of the person making the gift – this means that there is a pattern of gifting or evidence of an intended pattern of gifting; and
(b) that the gifts were made out of his/her excess income – It is essential that any gifts are made out of excess income. If the person making the gifts has to dip into capital reserves as they do not have enough income remaining, the exemption will not apply; and
(c) that, after allowing for all transfers of value forming part of his normal expenditure, the transferor was left with sufficient income to maintain his usual standard of living.
If considering making gifts made out of excess income, it would be wise to keep clear records of your intentions.
5. Gifts in consideration of marriage / civil partnership (s.22 IHTA)
This exemption allows gifts to be made without there being any IHT consequences. The amount that you can gift depends on your relationship to the recipient:
Maximum sum that can be gifted without IHT consequences (per person)
Up to £5,000
Grandchild or Great-Grandchild
Up to £2,500
Up to £1,000
In order to qualify, the gift should be made in contemplation of a particular wedding (not just generally ‘for if or when you marry’) and should ideally be evidenced in writing.
6. Gifts for family maintenance (s.11 IHTA)
A little known exemption is gifts for family maintenance. Payments for education or maintenance made to children who are under the age of 18 or undergoing full time education and maintenance payments to dependant relatives can be exempt from IHT, without the donor having to survive the 7 year period usually associated with gifting.
The most recent case concerning this particular exemption is McKelvey v HMRC in which the deceased had lived with her elderly, blind and frail mother, acting as her carer. The deceased was diagnosed with terminal cancer and before her death, made gifts of two houses which were valued at £169,000 to her mother. The executor to the estate argued that these gifts should fall under s.11 IHTA as they were ‘reasonable provision’ for the mother’s care and maintenance.
The Special Commissioner held that based on the annual cost of care for the mother and her life expectancy, £140,500 worth of the properties fell within s.11 IHTA and was therefore exempt from IHT.
7. Potentially Exempt Transfers (PETs) (s.3A IHTA)
This is the most well-known example of estate planning. This is a gift between individuals with the effect that no IHT is payable at the time of the transfer. Generally speaking, the transfer becomes exempt from IHT if the person making the gift survives 7 years after making the gift, whereas if the person making the gift dies within the 7 year period the PET becomes chargeable for IHT.
The value which is taxed is the value at the date the gift was made (unless the value has fallen, in which case it is the lower value that is taxed). It is therefore sensible from an estate planning perspective for people to consider gifting assets that are likely to increase in value.
Nicky gifts a painting to her daughter worth £20,000. Nicky dies 5 years later at which time, due to the death of the artist, the value of the painting has increased to £100,000. As Nicky has not survived 7 years, the value of the gift is included for IHT purposes. However, the value to be included is the value at the time the gift was made.
For a PET to be effective, you must not continue to benefit from the gifted asset. This is known as a ‘Gift with a Reservation of Benefit’. A common example of this occurs when you gift your home to your children but continue to live in the property. A ‘Gift with a Reservation of Benefit’ will mean that the value of the gifted asset will remain in your property for IHT purposes, even if you survive 7 years after making the gift.
In this article we have explored some ways in which an individual can mitigate their exposure to IHT. Reducing the size of your estate can reduce your IHT liability, but it will also make you poorer – although when considering this type of planning, that is the whole point! – It is therefore strongly advised that proper legal and financial advice, specific to your individual circumstances is sought before any decision is made. If you would like to speak with a member of our team, please contact us.
 Domicile is quite a complex concept in law, but at its simplest it refers to the place that a person has the greatest connection to and is usually the place where they were born. If you think you may have a domicile question, you should seek advice.