Gifting breaches risk unexpected IHT bills
A general misunderstanding of how the rules work when making a lifetime gift to an individual (known as a potentially exempt transfer (PET)) has resulted in many families facing an unexpected inheritance tax (IHT) bill.
IHT thresholds have been frozen for 17 years and will remain so until at least 5 April 2031. It’s therefore no surprise that more individuals than ever are making PETs with the aim of minimising the IHT liability when they ultimately die. However, the way in which PETs work can be complex.
Understanding the seven-year rule
The amount of IHT payable on failed PETs has increased substantially in recent years. The fact that a PET only becomes completely exempt if the donor lives for seven years is well understood.
A common misconception, however, is that the IHT payable in respect of a PET reduces on a sliding scale if the donor lives for between three and seven years.
This misconception arises because of the way in which taper relief works: the relief only comes into play if some (or all) of the PET is not covered by the donor’s £325,000 nil rate band.
For example: An individual makes a PET of £250,000, then dies six-and-a-half years later. The misconception is that the value of the PET will be reduced by 80% because of taper relief. The reality is that the £250,000 gift is fully covered by the donor’s nil rate band, and only the remaining nil rate band of £75,000 is then available to set against the estate. The end result is that the gift of £250,000 will have saved very little IHT.
IHT remains a tax that is paid on fewer than one in 20 estates, but receipts have increased, with the total number of deaths incurring the tax increasing by 3.6% between 2022/23 to 2023/24, the most recent statistics. There is an increasing perception that IHT has moved from being a tax on the wealthy, to a penalty on a wider range of estates. A wealthy individual able to afford gifts in the millions is much more likely to benefit fully from taper relief. Taking advantage of available allowances and ensuring gifting is used correctly is therefore becoming increasingly important.
HMRC’s basic guide to how IHT works, including taper relief, can be found here.
