“How can I reduce inheritance tax?”
Is a question our Accountants in St Albans are answering frequently. Whether it pertains to property or wealth, wanting to ‘avoid’ or minimise inheritance tax is important for each family generation.
Soaring property prices and frozen tax thresholds are pushing thousands of families' estates outside the Inheritance Tax (IHT) tax-free allowance, or Nil-Rate Band (NRB), of £325,000.
The number who pay the 40pc charge is expected by the Office for Budget Responsibility to rise from around 40,000 this year to almost 50,000 by 2027.
Fortunately, if you are at risk of paying the tax, there are plenty of things you can do to slash your bill.
But don't forget, seeking professional advice from your local accountant is recommended. Especially if your tax situation is complex.
You could consider these gifts as an effective, albeit limited, way to reduce your Estate and therefore the eventual inheritance tax liability. These must be outright gifts and so you should ensure that they would not affect your income or security as you will forego the right to the income or capital in the future.
- Annual £3,000 exemption – This exemption should be used by most people who have an inheritance tax problem, provided the capital is liquid and not tied up in property. The amount is per person and so each spouse can make a gift of £3,000 per financial year.
- Any part of this exemption not used in one year can be carried forward to the following year only. However, that year’s exemption must be used completely before using the part, which has been carried forward.
- For people with large IHT problems, a gift of £3,000 a year may not sound like it will have a significant impact. However, consider that a married couple can gift £6,000 a year, and over 15 years this would place £90,000 outside of your Estate, thus saving £36,000 in inheritance tax.
- It is important to ensure the money does not come from capital or the 7 year rule will apply if it's over £3,000 a year. Other gifts over £3,000 per year from capital made directly, are Potentially Exempt Transfers (PETs) which fall back into your Estate if you do not survive 7 years after making the gift.
Note that Gifts from one spouse or civil partner to another are always immediately free of inheritance tax. There is no limit as to the amount of the gift between spouses.
Gifts from grandparents: Each grandparent has an allowance of £2,500 in consideration of marriages of grandchildren. In this case, if the gift is to be effective for inheritance tax purposes, it has to be made before the wedding and of course, the wedding has to happen.
Gifts from parents: Each parent has a gifting allowance of £5,000 in consideration of the marriage of their children. It must be gifted before the marriage and the marriage has to take place.
Charity gifts: All gifts to registered charities are immediately exempt from inheritance tax. The same occurs for gifts to charities in your Will.
Other gifts: Gifts for national purposes, political parties, housing associations and certain transfers to employee Trusts, are also free of inheritance tax. You can also give as many gifts of up to £250 per person as you want during the tax year as long as you have not used another exemption on the same person.
Gifts out of Normal Income
One of the most lucrative IHT breaks is the “gifts out of surplus income” rule. Yet it is very underused. Only 430 families utilised it last year, according to a Freedom of Information request submitted by The Telegraph.
The rule allows any taxpayer to give away unlimited sums of money without getting caught by IHT – as long as the gifts do not diminish their quality of life and the money comes out of income, not capital.
This is very useful for people who have a higher income than they use on a normal basis. These gifts must be regular and habitual. The intention to make them regularly should be recorded in writing, signed and witnessed. The document should then be kept with your Will. Any income that is potentially taxable for income tax can be used, including income from investments or property. Care must be taken as the funds must be from income and not capital.
The regular gifts of income should also not affect your standard of living, and so producing an income and expenditure breakdown is also useful in the event the gifts are challenged by HMRC.
What does ‘normal expenditure’ mean?
The gifts should form part of a pattern. In its manual IHTM14242, HM Revenue & Customs (HMRC) advises staff to look back over a period of at least three or four years to see if the gifts are given on a regular basis.
A single gift will qualify only if there is strong evidence that it was intended to be the first in a pattern. The gifts should ideally be around the same size.
However, the taxman will accept gifts of different sizes if the donor’s income is variable – if it derives from dividends, for example – or if the gifts are related to costs that are variable, such as school fees.
If one of the gifts is unusually large, HMRC may decide that part of it is “normal” but exclude the amount above this. Generally, the safest thing to do is to give a similar sum on a regular basis.
Keep Written Records
It is important to keep a written record of all gifts made. If applicable, advise your accountants of them so that they can be correctly dealt with from a tax and reporting point of view. This will also ensure you benefit from any available relief.
- Record your income and expenditure and keep bank statements and tax returns to prove the gifts are easily affordable and do not affect your normal standard of living.
- Do this annually to prove the money came from income. (Take care it’s not investment bond income as that is return of capital). Rule of thumb; if income tax is due on it, then it's income.
- Document the reason and intention of the gift and specifically state it is not a loan.
- State it is to be made regularly (ideally monthly as the gift is immediately exempt) and have that document signed and witnessed and kept with your Will.
Gifts into Trusts
Gifts into Trusts are classified as 'Chargeable Lifetime Transfers'; that is to say that, should the gift exceed the NRB of £325,000, tax is immediately payable at 20% on the excess.
Do not make gifts into a Trust without proper and experienced advice as merely making gifts in the wrong order can potentially cause an increased tax liability.
Never make a gift of any part of your main residence without taking good advice. Often, once income tax as been paid on the rental income and Capital Gains tax is applied to the growth of the percentage gifted, this is not worthwhile.
Ask your Accountant or Financial Adviser for Advice
Seek professional advice from your accountant or financial adviser.
“Minimising inheritance tax is a common concern for families in St Albans, as it can have a significant impact on the financial well-being of future generations. Our accountants are experts in helping clients develop strategies to reduce their inheritance tax liability and protect their assets.
By taking proactive steps, such as making annual gifts to loved ones and utilising tax-efficient trusts, families can significantly lower the amount of inheritance tax they owe. Our experienced team can provide personalised advice and guidance tailored to your specific circumstances.”
Chris Wallace, Tax Expert in St Albans
Specifically, if you are considering making ‘gifts out of normal income’, we can help. Speak to Chris Wallace, your local Accountant in St Albans for clear easy to understand advice on reducing Inheritance Tax.