My net recorded income is approximately £90,000 and expenditure is approximately £70,000 per tax year. Can I gift the entire £20,000 difference annually without incurring inheritance tax (IHT) on any of it?
DL
Robert Barwise-Carr, tax director at Mazars UK says:
IHT is usually chargeable at a rate of 40 per cent on the value of a person’s estate at death to the extent that the estate exceeds the available nil-rate band, which is currently £325,000.
Many people look to make lifetime gifts to reduce the value of their estate and the amount chargeable to IHT on their death. The general rule is that lifetime gifts made to individuals are potentially exempt transfers (Pets). No IHT liability arises when a Pet is made and, provided the donor survives for seven years after making it, the Pet is completely free of the tax. Even if IHT does not apply, capital gains tax may be due when the gift is made. If the donor passes away within seven years of making the gift, IHT will be chargeable on these failed Pets at a maximum rate of 40 per cent. The rate of tax is reduced by taper relief if more than three years have elapsed since the date of the Pet.
Successful Pets rely on the donor surviving for seven years, which is why the exemption for normal expenditure out of income can be particularly useful. Regular gifts made out of surplus income are not subject to IHT even if the donor dies within seven years. There is also no monetary limit on the exemption, although certain conditions need to be met and some exceptions apply.
All the following conditions need to be met in order for the exemption to apply.
For expenditure to be considered 'normal'. it has to be regular and typical. HM Revenue & Customs (HMRC) looks at multiple factors to determine whether expenditure meets this definition, such as frequency, amount, nature of the gifts and identity of the recipients. And normal expenditure for one person may be very different to normal expenditure for another.
Gifts made on a regular basis are more likely to be normal expenditure as are gifts of similar sizes, although HMRC accepts that the amount of the gifts may be made by reference to variable income. All factors need to be considered to determine whether there is a regular pattern of gifting.
Gifts must be made out of income, which means that the donor cannot claim the exemption on the gift of a capital asset, or sell a capital asset and claim the exemption on a gift of the proceeds.
Whether a gift is made out of income will be a matter of fact. The donor’s income and expenditure each year should be reviewed to verify the level of excess income available. If a donor’s income fluctuates from year to year, HMRC looks at the income and expenditure over multiple years.
To meet the condition that the donor is left with sufficient income to maintain their usual standard of living, they must not deliberately reduce their expenditure such that it impacts their normal standard of living. Again, what is considered a normal standard of living varies significantly from one person to another and should be considered on an individual basis.
You asked whether you could make gifts of £20,000 a year, this amount being the difference between your annual income and expenditure. On the face of it, a gift of this amount would be made out of your income and should still leave you with sufficient income to maintain your usual expenditure. You should keep detailed records of your income and expenditure each year to support this position.
It’s important to note that cash will not retain its character as income indefinitely and HMRC usually treats accumulated income as capital after two years, although there is no hard and fast rule.
The gifts should also be regular to demonstrate that they are part of your normal expenditure. We recommend documenting your intention to make regular gifts, and this could be done by setting up a regular direct debit and writing a letter outlining your intentions.
A tax adviser could support you by reviewing the position and maintaining records.
