Gifts out of income and a thinktank’s take on Inheritance Tax

George Hay Chartered Accountants

Gifting surplus income to family members is often touted as an excellent way of planning for the future and can help to reduce the liabilities associated with a person’s estate. But how do the rules relating to gifts work in practice?

Most people are aware of the £3,000 annual exemption that anyone can give away, without having to worry about the future IHT implications, but you may want to give away a larger sum.

If that’s the case, there is much more generous relief, which is generally not well known, for gifts provided from surplus income.

Gifts provided from surplus income – i.e. income less your outlay to preserve your standard of living – are not considered as remaining part of a person’s estate, regardless of how long they survive for after the gift has been given and should, therefore, be free of any inheritance tax (IHT) charge.

Under the current rules, there is no limit on the sum that you can give away as a gift out of income, but it is recommended that a letter of intent is prepared upon doing so.

This documentation can be provided to HM Revenue & Customs (HMRC) in the event of a short period of giving due to a change of personal circumstance. In addition, unlike lifetime gifts, there is no requirement for the donor to survive seven years for the gifts to be free of IHT.

Where gifts are to be made to a minor, and regular payments may not be suitable, then a discretionary trust, into which the payments are made, might be more appropriate.

Ordinarily, IHT is immediately chargeable at 20% on the transfer of income into the trust if the Nil Rate Band, currently £325,000, is exceeded, although the accumulated income in trust will not use up the Nil Rate Band. However, this does not apply where regular gifts out of income are made.

Please note that there is an IHT charge every 10 years, calculated based on the value of the trust’s assets at the date of the 10-year anniversary, and the maximum tax rate is six per cent. The 10-year charge can be circumvented by distributing the assets held in the trust prior to the 10-year anniversary.

Alternatively, different trusts could be established with the amount invested into each trust limited so that the Nil Rate Band is not exceeded at the 10-year anniversary of the trust. However, the growth in the value of the assets held in the trust would also need to be considered.

The trust should have no other assets in addition to the regular gifts out of income and each should be set up on a different day. Multiple trusts set up on the same day are aggregated to determine whether the Nil Rate Band has been exceeded at the 10-year anniversary.

Those considering giving away surplus income should retain a record of the gifts and document their income during the fiscal year, including expenses, as executors will need this information to ensure no IHT is payable after death.

On the subject of IHT, last month thinktank the Resolution Foundation suggested that the Treasury returns to the drawing board when it comes to taxing bequests and inheritances, referring to their belief that the current system of Inheritance Tax is not fit to deal with the ‘societal shift’ that is taking place.

This comes as the issue of intergenerational fairness continues to hit the headlines.

Instead of Inheritance Tax (IHT), the Resolution Foundation put forward the idea of a ‘lifetime receipts tax’, which would grant individuals a lifetime tax-free allowance, with further thresholds above this amount for lower and higher rates of tax.

Perhaps the most radical facet of the proposal is that it would tax beneficiaries, rather than estates. The Resolution Foundation suggests that this would act as an incentive for people to allocate their wealth more widely.

It is estimated that such a change could raise an extra £5 billion for the Government, by 2020-21. The current system raises just 77p in every £100 raised through taxation and only applies to the largest four per cent of estates.

Many people put off Inheritance Tax planning and tend to think it is only something worth considering in old age, but this is simply not the case. Starting the planning process sooner, rather than later, means better protection for your wealth. We share your concerns about paying Inheritance Tax but with knowledge of your circumstances and careful preparation this can be minimised.

To talk to one of our experts about Inheritance Tax planning, contact us today.

Link: Calls for complete overhaul of ‘unfit’ inheritance tax system

Link: Inheritance Tax: Gifts