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How can unspent income from lockdown cut future inheritance tax bills?

View profile for Marc Dorsett
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Internet shopping may have boomed during lockdown, but many people have spent less money than they would have while the national lockdowns have been in place. Therefore, those with spare money have an unusual opportunity which allows them to make the most of inheritance tax reliefs on gifts to family and friends.

Giving away assets while you are alive can reduce the size of your estate for inheritance tax (IHT) purposes, IHT is charged at 40% so it’s worth doing regular checks on your financial position to see if you are in a position to gift additional assets while alive.

The current reliefs in place allow for everyone, on death, to receive a tax free allowance of £325,000, this is known as the Nil Rate Band (NRB). In addition to the NRB there is a possible additional allowance of £175,000, if the main residence is passed to a direct descendant (i.e. your child). If you are married or in a civil partnership, you can leave everything free from IHT to your spouse, and on the death of the surviving spouse, the balance of the NRB's are added together and IHT is calculated on the combined value of the estate.

Whilst alive, you can make gifts from your assets, making these gifts can help reduce the value of the estate and subsequently the tax due on death.

Tax free life gifts fall under two headings:

1. Automatic exempt gifts; and

2. Gift exemption that can be claimed after death

The automatic exempt gifts include an annual exemption to allow the gifting of up to £3,000, together with a separate small gifts allowance of up to £250 per person per year.

The annual exemption of £3,000 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. 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, if you leave at least 10% of your net estate to a charity organisation the IHT rate on death is reduced from 40% to 36%.

When a gift is made to an individual out of capital, rather than income, it is known as a potentially exempt transfer because it drops out of account and will 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 when working out the IHT payable by the estate.

A gift exemption which can be claimed after death includes regular gifts from surplus income. Surplus income is defined as the left over income that you have after you have lived to your normal standard and all your usual expenditure has been paid for, without using any savings.

Record-keeping is essential when making a gift, as a gift will only qualify for exemption if it is part of a regular pattern of giving and you can demonstrate that it came from your surplus income. 

If anyone has a surplus of income that has built up during lockdown, it’s a good idea to review this whilst it is still current income. To make such gifts, it is essential you record your intention in writing, keeping a simple record of income and outgoings during the year.

The exemption for regular gifts from surplus income must be claimed after death by the personal representatives, due to the exemptions not being an automatic relief. The personal representatives must be able to demonstrate the criteria for the exemption have been met, in particularly that the gifts were made out of surplus income and that you were able to maintain your normal lifestyle.

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 to deal with HMRC after your death. 

If you would like to review your potential exposure to IHT please contact our Private Client tax on 01245 228125 or PrivateClientEnq@gepp.co.uk

This is not legal advice; it is intended to provide information of general interest about current legal issues.