Gifting and Its Role in Inheritance Tax

When planning your estate, gifts can play a meaningful role in reducing inheritance tax exposure. However, the rules around gifts and inheritance tax (IHT) are nuanced, and mis-steps can lead to unexpected tax liabilities. This article explains how gifting works in the IHT context and how to use gifting as part of tax-efficient estate planning.

Key Concepts in Gifting and Inheritance Tax

Nil Rate Band & Residential Nil Rate Band

• Every individual in England & Wales currently has a nil rate band (NRB) of £325,000. Any estate value above that threshold may be subject to IHT.
• Additionally, a residence nil rate band (RNRB) of £175,000 may apply when passing a residence to direct descendants (children or grandchildren) on death.
• Spouses/civil partners can use the unused portion of their partner’s IHT allowances on death, potentially increasing the effective allowance for a married couple.

(These thresholds are subject to change, so it’s vital to check the prevailing limits.)

Types of Gifting & Their Tax Treatment

1. Annual Exemption / Gift Allowances

• Each tax year, you may give up to £3,000 as tax-free gifts (the “annual exemption”). If you did not use this in the prior tax year, you can carry it forward, meaning a gift of up to £6,000 may be allowable in certain circumstances.
• Additionally, you can make small gifts of up to £250 per person per tax year (provided that no other gift to the same person in the year uses the annual exemption).
• Qualifying gifts for weddings or civil partnerships (to a child, grandchild, etc.) also have specific permitted amounts under IHT rules.

These exempt gifts reduce your taxable estate immediately, and you don’t need to survive for any fixed period for them to be effective, assuming they are within the allowances.

2. Potentially Exempt Transfers (PETs)

• Gifts that exceed the above exemptions tend to fall into the category of Potentially Exempt Transfers (PETs).
• When you make a PET, you must survive 7 years for the gift to fall fully outside your estate for IHT purposes.
• If you die within 7 years of making the gift, the gift (or part of it) may be brought back into your estate and taxed under IHT rules.
  • The amount brought back depends on how many years have elapsed between making the gift and death.
  • In many cases, for gifts made over £325,000, there is taper relief, which gradually reduces the IHT paid if death occurs between 3 and 7 years after the gift.

3. Gifts with Reservation of Benefit

• If you give away property or assets but continue to benefit from them (for example, gifting your home but still living in it without paying a full market rent), the gift may be deemed a “gift with reservation of benefit”.
• Such gifts may still count as part of your estate on death for IHT purposes effectively negating the intended tax relief of the gift.

How Gifting Strategically Supports Estate Planning

• Reducing the value of your taxable estate: By making gifts during your lifetime (within exemptions or which qualify as PETs), you lower the amount that could be exposed to IHT on your death.
• Using timed gifting: Gradually gifting over multiple years can help remain within allowances, mitigate sudden large transfers, and allow for more predictable planning.
• Utilising exemptions fully: Ensuring that you consistently use the annual £3,000 exemption (or carry-forward, when applicable) and the small gifts exemption can cumulatively make a difference over time.
• Aligning with other strategies: Gifting works best when combined with a holistic estate plan including wills, trusts, lifetime giving, insurance, charitable donations, etc.

Practical Considerations & Pitfalls to Watch

• Record-keeping is essential: Document the date, value, recipient, and nature of all gifts. Good records are vital if HMRC or your executors need to assess your estate.
• Valuation issues: For gifts of property, shares, or other non-cash assets, accurate valuation at the time of the gift is needed.
• Cash gifts exceeding certain thresholds: If large sums are paid by cheque, bank transfer, or other traceable means, they are presumed to be gifts unless shown otherwise.
• Recipient’s tax liability: If a PET fails (i.e. the donor dies within 7 years), the recipient of the gift is generally liable to pay the IHT arising. However, a donor’s will can be drafted to shift this burden onto the residuary estate instead.
• Interaction with trusts: Placing assets into certain trusts introduces additional tax rules and may remove the direct control over those assets.
• Gifts with strings attached: Gifts that impose conditions or restrictions may result in it being considered a gift with reservation.

Birthday, Holiday & Special Occasion Gifts

While gifting for occasions like birthdays, Christmas, anniversaries or other seasonal holidays is common, from a tax standpoint such gifts are treated in the same way as other lifetime gifts. The timing or occasion does not generally affect the tax treatment. What matters is:

• Whether the gift falls within exemption limits (annual, small gifts, wedding gifts, etc.),
• Or whether it is a PET,
• And whether you survive the requisite period after making it.

Hence, while you may choose to give more or special gifts at birthdays or holidays, it’s the value, timing, and legal structure that determines the tax effect.

Best Practices for Effective Gifting & IHT Planning

• Start early — making regular, modest gifts over time often works better than large transfers near the end of life.
• Use annual exemptions every year and carry forward unused allowances where permitted.
• Consider professional valuations for non-cash gifts.
• Keep detailed written records of gifts, including the nature of the gift, recipient, date and value.
• Review and update your will to reflect your gifting strategy, especially regarding liability for failed PETs.
• Consult specialist tax or estate planning advice to integrate gifting with the rest of your estate plan.
• You may also wish to use other reliefs such as normal expenditure out of income rules to gift larger sums.

If you require assistance with estate planning or the preparation of your Will, please do not hesitate to contact our Trusts & Estates Department, Heather Lally on 01244 354800 or email: heather.lally@dtmlegal.com.

This article is not intended to be comprehensive or to provide specific legal advice. It should not be relied upon in the absence of specific advice given in relation to particular circumstances.

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