The HM Revenue and Customs (HMRC) has intensified its scrutiny on gifting rules, recovering £624 million from nearly 2,000 individuals who mistakenly believed they had reduced the value of their estates through gifts, only to have inheritance tax relief revoked.
Inheritance tax (IHT) is charged at 40% on individual estates worth more than £325,000, a threshold that can double for married couples. Various allowances and exemptions can increase this threshold or reduce the IHT rate. One significant relief is the seven-year rule, which allows people to give away assets to lower their estate’s value and pass on more wealth. However, a Freedom of Information request revealed that since 2016, 1,830 gifts worth £624 million were deemed taxable at 40%.
Understanding the Seven-Year Rule
The seven-year rule permits tax-free gifts of property and other assets if the giver survives for at least seven years after the transfer. Assets can include money, property, land, jewellery, cars, shares, insurance payouts, and jointly-owned items. If the giver dies within seven years, the gift may be included in the estate’s value for IHT purposes if it exceeds £325,000. Gifts made within three years of the giver’s death are taxed at the full 40% rate, while those made three to seven years prior are taxed on a sliding scale:
- 3 to 4 years: 32%
- 4 to 5 years: 24%
- 5 to 6 years: 16%
- 6 to 7 years: 8%
Gifts with Reservation of Benefit
A common pitfall is the “gift with reservation of benefit,” where the giver continues to benefit from the gifted asset. The most frequent example is living in a property gifted to a descendant without paying market-rate rent. If HMRC identifies such arrangements, the gift’s value is included in the giver’s estate for IHT purposes.
In these cases, not only does the gift lose its tax-exempt status, but the recipient may also face additional taxes. If the recipient receives rental payments from the giver, these are subject to income tax. Furthermore, if the recipient sells the gifted property and owns another main residence, they may incur capital gains tax.
Gifting into Trusts: An Alternative
An alternative to direct gifting is placing assets into a trust. Trusts can offer more control over how assets are managed and distributed, potentially avoiding some of the pitfalls of direct gifts. However, trusts have their own tax implications and regulations, so professional advice is crucial.
The Mechanics of Gifting and Tax Implications
Gifting involves transferring assets without expecting payment in return. While this can reduce the value of an estate and potentially lower IHT liability, it’s essential to understand the tax implications. Misunderstanding gifting rules can inadvertently leave families worse off, especially with rising property values pushing more estates into the IHT threshold.
Property Gifts: If the giver continues to live in the property without paying market rent, it remains part of their estate.
Cash Gifts: Cash gifts can be exempt if the giver survives seven years. However, using cash gifts as loan notes to retain control can fail the tax-exemption test.
Commercial Implications
Improper handling of gifts can result in significant tax liabilities for both the giver and the recipient. Executors of estates are responsible for settling any outstanding IHT, which can be a substantial financial burden.
Care must also be taken to understand the capital gains tax implications when gifting assets to connected persons.
Plan Your Estate Wisely
There are often more effective strategies than gifting to reduce the value of your estate. It’s crucial to seek professional advice to navigate the complexities of IHT and estate planning.
Talk to us about your estate planning needs to ensure you make informed decisions and avoid potential tax pitfalls.
Author: Louise Berry, Tax Manager
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Date published: 09 July 2024