IHT Exemptions for Gifts: A Comprehensive Guide

Making a gift to your family while you’re still alive can be a great way to reduce the amount of inheritance tax (IHT) you pay. However, IHT is a complex area of tax planning and you can’t simply gift a large proportion of your estate to a family member as you please without facing some tax implications. Luckily, there are IHT exemptions for gifts that you can take advantage of.

At Newnham & Son, we believe it’s important for you to know about the various legal IHT exemptions available. With this in mind, we’ve created this article to give you more information on an inheritance tax exemption for gifts that you may find particularly attractive if you don’t want to wait for the usual seven-year period to pass.

Conditions of the ‘Normal Expenditure Out of Income’ Exemption

In terms of IHT tax relief, the ‘normal expenditure out of income’ is the most generous. This is because the exemption is limited broadly by the amount of surplus income available as well as the individual’s personal circumstances. A person can benefit from this exemption, however, they have to meet certain conditions. Here are the three most important ones:

The gift must be part of your normal expenditure.
The gift should come out of your income.
You should still be able to maintain your usual standard of living after making the gift.

While you may feel like these conditions are straightforward, every individual’s circumstances differ. With this in mind, it can be challenging to determine whether you are eligible for this IHT exemption. Furthermore, HMRC applies this rule based on its own interpretations of case law and legislation.

The Seven Year Wait

Normally, if you make a gift to someone, this gift is a potentially exempt transfer (PET) for IHT purposes. However, this only becomes an exempt transfer if you survive at least seven years after making the gift. If you are eligible for this exemption, your estate will be worth less. That said, the seven-year period won’t apply.

What Is ‘Normal’?

When referring to ‘normal’ expenditure, the lines are blurry. As far as HMRC is concerned, the rules vary according to the person. For example, if you make multiple gifts, you may not qualify for any IHT exemptions. On the other hand, if you make a recurring gift to a person, HMRC may view this as part of your normal expenditures out of your income. HMRC will usually make their decision based on a ‘reasonable period’. This would be between three and fours year.

While the ‘reasonable period’ may seem long, you might be able to establish a giving pattern more quickly. For example, a standing order from your bank account to the giftee and a signed ‘gift memorandum’ that confirms your intention of this gift being a regular occurrence will support your claim.

Defining Income

You may also find that HMRC asks for evidence regarding the ‘out of income’ condition. This is especially relevant if your income fluctuates dramatically each year. You may have the opportunity to carry income from a good year to a bad one, however, HMRC could challenge tax exemptions on gifts in this instance.

With the above in mind, it’s essential that you clearly define your surplus from your capital. For example, if you make £25k a year and make a gift of £100k one year, HMRC would come to the conclusion that the gift isn’t from your annual income. They may also conclude that this donation leaves you without sufficient income to maintain your current living standards.

The Key to Qualifying for IHT Exemptions

If you want to claim the normal expenditure out of income exemption, you need to get your records in order. HMRC provides a helpful form called IHT403 which will help you demonstrate that you made gifts from your excess income. This form also includes a spreadsheet which allows you to keep records of your income, expenditures and any extra earnings.

While this form will help you organize your finances to make the most of IHT exemptions, it’s important that you seek professional advice in order to avoid paying excess inheritance tax. Luckily, at N&S, we can help you with all matters relating to inheritance tax planning.

To find out more about our services or to book a consultation with one of our trained professionals, contact us today. Our team is always happy to lend a helping hand.