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Inheritance tax planning and tax-free gifts

By Ian Robinson

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Inheritance tax planning and tax-free gifts

You're allowed to make some gifts without your heirs having to pay any tax at all.

Gifts always tax-free

  • Gifts between a husband and wife or civil partners.
  • Gifts to UK-established charities, national museums, universities, the National Trust and certain other bodies Gifts to political parties (broadly those represented in parliament with at least two MPs). Gifts to registered housing associations and community amateur sports clubs.
  • Most gifts to people made more than seven years before your death They must be to people as opposed to trusts or businesses.
  • Gifts made as part of your ‘normal expenditure’ This exemption allows you to give away money from surplus income, providing the gift doesn’t reduce your standard of living, is not from capital and forms some pattern of regular spending. A good test is whether the money comes from your current account.
  • Gifts to people getting married Up to: £5,000 from each parent of the couple; £2,500 from each grandparent or more remote relative; £2,500 from bridegroom to bride (and vice versa) and between civil partners; £1,000 from anyone else.
  • Any number of gifts up to £250 to each recipient These gifts are meant to cover things such as birthday and Christmas presents.
  • Gifts for maintenance Of husband, wife or civil partner, ex-husband, ex-wife or ex-civil partner and relatives dependent on you through old age or infirmity. And for maintenance, education or training of your children (including step and adopted children) in full-time education or aged 18 or under.
  • Gifts up to £3,000 in total in each tax year You can't combine these with a £250 gift to the same person. Husbands, wives and civil partners each have £3,000 limit. You can carry any unused part forward one year only, to the next year. This gift is known as the ‘annual exemption’.

Gifts that might be tax-free

Most gifts you make to other people during your lifetime (unless they fall into the list of tax-free gifts) are classified as ‘potentially exempt transfers’ or PETs for short.

If you survive for seven years after making the gift, no inheritance tax is due. However, if you die within this time, two things happen.

The PET is reassessed

The PET is reassessed and added to any other taxable gift you may have made in the seven years before making the PET, including assets put into trust. This has to happen to see whether any tax is now due on the PET itself, because your allowance has been used elsewhere. This means that assets put into trust up to 14 years before death could be relevant.

If tax does become due on a PET, the person who received the PET will be asked to pay the tax. However, the tax due may be reduced because of ‘taper relief’.

This is how taper relief can reduce tax due on PETs:

  • If the gift was made less than three years before death, no reduction in tax is due
  • If the gift was made three to four years before death, tax is reduced by 20%
  • If the gift was made four to five years before death, tax is reduced by 40%
  • If the gift was made five to six years before death, tax is reduced by 60%
  • If the gift was made six to seven years before death, tax is reduced by 80%.

If the seven-year running total of taxable gifts and PETs made comes to less than the tax-free allowance (at the date of death), no tax will be due on the PET.

While taper relief may reduce tax on PETs if you die within seven years of making them, it won’t reduce the tax due on your estate.

The PET is added to your estate

The second thing to happen if you die within seven years of making a PET is that the PET is also added to your estate to work out how much tax is due on the estate. If the seven-year running total of PETs, chargeable gifts and your estate comes to less than the unused tax-free allowance, no tax will be due.

However, if much of the tax-free allowance has been used up against PETs and taxable lifetime gifts, this can leave little or no allowance to be used against the rest of the estate.

Get a personalised answer for your tax queries

The Which? Money Helpline offers independent one-to-one guidance on all types of tax issues, including those involving inheritance tax. If you're not a Which? member, and you'd like to get unlimited access to our Money Helpline experts, you can try Which? Money for two months for £1.

  • Last updated: April 2017
  • Updated by: Tom Wilson

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