Gifting and inheritance tax: what you need to know

In 2022/23, 31,500 estates were subject to inheritance tax. That is around one in 20 deaths. This represented an increase of 13% from the previous year. It is predicted that, given inflation, frozen thresholds and proposed reforms, more estates will be subject to an inheritance tax liability. If done properly, gifting can be a powerful tool to mitigate inheritance tax.

What is a gift?

Broadly speaking, a gift happens when you give away money, a house, land, stock and shares or household and personal goods (for example, jewellery, cars or antiques) to another person.

The definition of a gift is not as straightforward as it may initially seem. It can also include paying for the private school fees of someone who is not your child or selling your property for below the market value.

Inheritance tax may arise on the value of a gift. There are, however, some exemptions and reliefs for inheritance tax purposes which should be considered.

Annual exemption

You can give up to £3,000 per tax year (6 April to the following 5 April) free of inheritance tax. This is an allowance specific to you and includes all gifts made during the tax year.

If you have never gifted before or have an unused portion of your annual allowance from a previous tax year, you can carry forward that unused portion to the next tax year.

Small gifting allowance

You can gift up to £250 per person per tax year. This would cover any gifts made at Christmas or birthdays, for example.

You cannot use this allowance if the beneficiary of the gift has benefited from any other exemption, such as your annual allowance.

Gifts for weddings and civil partnerships

A wedding or civil partnership is a special occasion, and it is recognised that you may wish to gift to the happy couple. You can give the following amounts free of inheritance tax:

• £5,000 to a child
• £2,500 to a grandchild or great-grandchild
• £1,000 to any other person.

Gifts out of surplus income

If your income is greater than your outgoings, you may be able to gift your net surplus income with no inheritance tax consequences. Your net surplus income is your income minus all your usual living expenses such as mortgage payments, food, clothing, holidays etc.

This is a powerful estate planning tool which can stop the value of your estate from growing, and in return your inheritance tax bill increasing.  

There is no upper limit for how much surplus income you can give away, provided that:

• the gifts are made strictly from income, and not capital
• your usual standard of living does not suffer to enable you to gift
• you keep meticulous records detailing your income and outgoings.
  
  

The seven-year rule and inheritance tax

Gifts which do not attract an exemption may attract inheritance tax if you do not survive for seven years from the date of the gift. If you die within seven years, the value of the failed gift will be brought back into the value of your estate for inheritance tax purposes. If the value of your estate, including the value of the failed gifts, exceeds your inheritance tax allowances then inheritance tax will be due. The current rate of inheritance tax is 40%.

If the value of the gift exceeds £325,000 (known as the nil-rate band) and you die after three years of making the gift, taper relief may apply. The rate of inheritance tax will ‘taper’ depending on how far into the seven-year period you die. The rates of taper relief are currently:

• 0–3 years: 40%
• 3–4 years: 32%
• 4–5 years: 24%
• 5–6 years: 16%
• 6–7 years: 8%
• 7+ years: 0%.
  
  

Gifts with reservation of benefit

When gifting an asset, you cannot retain any benefit from it. The golden rule of gifting is that you should not give away assets to which you still need, or want, to benefit from.

Common examples of gifts with reservation of benefit include:

• signing over the legal title to your home and continuing to live in it
• gifting cash or stocks and shares and continuing to receive the income
• signing over ownership to a car but continuing to drive it.

Unless certain onerous procedures are put in place, the value of a gift with reservation of benefit will be brought back into your estate for inheritance tax purposes. The seven-year rule does not apply to gifts with reservation of benefit.

The importance of accurate records

It is very important to keep accurate records when you gift, even if the gifts fall within an exemption. Ideally, these records should be kept for the past seven years and detail the type of gift (i.e. money or property), the recipient of the gift and the date of the gift. A copy of this schedule should be kept alongside your will or in a place known to your family members.

If done properly, gifting can be a useful tool to reduce an inheritance tax liability on your death. If you are considering making gifts, our helpful team at Birketts can advise you to ensure that you are gifting in a correct and tax-efficient manner.