How unspent income from lockdown could cut future tax bills

Internet shopping may have boomed during lockdown, but many people have spent less than usual while forced to stay home, and those with spare money have an opportunity to make the most of inheritance tax reliefs on gifts to family and friends if they act swiftly. 

Giving away assets while you are alive can reduce the size of your estate for inheritance tax (IHT) purposes, and with IHT charged at 40 per cent it’s worth doing a regular check on where you stand. 

Each person can pass on a maximum of £325,000 in assets tax free, including shares and property. There is an extra £175,000 allowance when the main home passes to a direct descendant.  If someone is in a marriage or civil partnership, they can leave everything free of IHT to their partner, and when the second partner dies, two allowances are added together when calculating whether tax is due on the combined value of the estate. 

But while alive, anyone can make gifts from their asset base, whether to those who will inherit when they die, or to other family, friends or charities they wish to support during their lifetime.  Making these gifts can help reduce the value of the estate and the tax due, if they follow some simple rules.  

Broadly, these gifts come under two headings: those where the allowance is automatic if the gift fits the rules, and those where the exemption must be claimed after death, such as gifts out of surplus income. 

Surplus income is what remains after you have maintained your normal standard of living and all your usual expenditure, without tapping into any savings or other retained assets.  Record-keeping is essential as a gift will only qualify for this exemption if it is part of a regular pattern of giving and you can demonstrate that it came from surplus, current income.  If time elapses and income is effectively moved to savings, then it is unlikely to fit the criteria.  

Amanda Voakes, Solicitor and Head of Private Client at Chattertons Solicitors said: “If anyone has surplus income that has built up during the lifestyle restrictions of the past year, it’s a good idea to review this swiftly while it is still current income.  To make such gifts, it is essential you record your intention in writing, and then keep a simple record of income and outgoings during the year, for example by taking the figures from your bank statements."

“The exemption for gifts from surplus income must be claimed after death by the executors of a person’s Will, because they are not given automatically.  The executors must be able to demonstrate that the criteria for the exemption, in particular that the gifts were made out of surplus income and that you were able to maintain your normal lifestyle, have been met.  This is why it is important to keep a record of income and expenditure.”   

When gifts are made to an individual out of capital, rather than income, they are known as potentially exempt transfers because they drop out of account and become wholly exempt if you live for seven years after the date of the gift. If you die within that seven-year period, the value of the gift must be brought into account in working out the IHT payable by the estate.  

Alongside these potentially exempt gifts, there are some automatic allowances, these include an annual exemption to allow gifting of up to £3000, together with a separate small gifts allowance of up to £250 per person.  

The annual exemption of £3000 can be gifted as a single sum to one person or divided among many.  It can also be carried forward one year but cannot be combined with the small gift allowance for anyone.  The small gift allowance allows any number of gifts of up to £250 per recipient, as long as no individual receives more than £250.

Gifts to charities and political parties are exempt and when you die the IHT rate on your estate will be cut from 40% to 36%, if you leave at least 10% of your net estate to charity.

“Whether dealing with automatic allowances, surplus income or other potentially exempt transfers, it’s a good idea to track all gifts as it will make it much easier when executors later have to deal with HMRC,” added Amanda.  “You should also make gifting part of a regular, annual review because the rules change and this will act as a prompt to keep record keeping up to date.  It’s also important to review your will if you have made any significant gifts.” 

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