Inheritance Tax – Normal, Habitual expenditure out of income
Gifts out of capital, over and above various thresholds, such as the annual £3,000 gift allowance, are Potentially Exempt Transfers (PETs), which remain in your estate for 7-years. So if a PET is made and death occurs within 7-years, the value of the gift is added back to the estate on death for IHT calculation purposes. However, if it can be demonstrated that a pattern of gifting had been established and that the amounts gifted were demonstrably affordable out of normal income, those gifts are exempt from the PET rules and are outside your estate immediately.
It must be noted that there is a requirement for there to be a pattern of gifting and the intention to do this should be evidenced in writing and kept with the Donee’s Will. Making, for example, a regular monthly payment of a set amount is clear evidence of the establishment of a pattern, to which I will refer in more detail later. However, HMRC accepts that, so long as there is adequate documentary evidence of the Donee’s intentions, the amounts paid can vary. Consequently, someone with a varying income could have a reckoning-up, say, every 3, 6 or 12-months, establish what the surplus is and then give that away.
Good record-keeping is essential, because the Executors will have to declare, as gifts, the payments made out of income in the seven Tax Years preceding the second death. Then, the Executors will have to prove that the payments were not a series of PETs, but that they did constitute normal, habitual expenditure out of income. To do this, the Executors will have to complete page 6 of form IHT403, which is a fairly detailed analysis of income and expenditure in each of those seven Tax Years and which would be difficult to draw-up post mortem. Consequently, when the Donee gathers together the information for their future Self Assessment Tax Returns, they also need to complete one column on page 6 of form IHT403, which they then need to keep with their Will. It is important to remember that whilst income from Individual Savings Accounts is not taxable and doesn’t have to be included in the Tax Return, it is income for the purposes of this exercise.
The use of this allowance for such things as education costs or general living expense will be obvious to Readers and establishing such payments via a standing order at the Bank helps to evidence the pattern.
The Financial Planner’s approach may include such things as:
- Paying Life Assurance premiums on a Whole of Life policy – see the Case Study.
- Making contributions to a pension, with those contributions benefitting from tax relief. Everyone under 75, including the youngest baby, has a minimum annual pension contribution allowance of £3,600. This is made-up of a net contribution of £2,880 (£240 per month) and £720 tax reclaimed by the pension provider, so is a great way to help someone save. Of course, pension savings can’t be accessed until age 55 (57 in 2028).
- Building-up funds either in cash or through investments to provide for education or other future expenses – house purchase, for example.
By achieving the above with monthly (or at least regular) direct debits also evidences the intention to establish a pattern of gifting.
If you believe you have an Inheritance Tax problem and want to know what legitimate steps you can take to mitigate this, contact me today, or complete the form below.