In the UK, we have been in lockdown measures since March 23, the sight and silence of closed business, leisure and other activities is familiar to us all. Behind closed doors is the increasing fear and uncertainty many people are now feeling about their day to day income and future financial security.
It is also a time to pause and consider what steps can be taken to assist family members or others. Gifts that could make a difference, large or small and with careful planning, help can be provided in a very tax efficient way.
Cash gifts to family members
There are Inheritance Tax implications to be aware of when making cash gifts to another individual.
Gifts can be exempt or potentially exempt from IHT depending on what they are.
An exempt gift reduces the donor’s estate (the person making the gift) immediately without any further conditions attached but a potentially exempt gift reduces the donor’s estate once the donor has survived a full 7 years from the date the gift is made.
Making gifts is simple, tax efficient and easy to administer on a practical level. For some, it is going to make sense to consider making gifts during these challenging times. Let’s take a moment to consider the sort of gifts that can be made:
There is a range of gifts which are small or relatively small in value and which are fully exempt from Inheritance tax:
Small gifts exemption
An individual can make a gift of up to £250 to any person in the tax year and this is fully exempt provided you have not used another exemption on the same person in the year.
Wedding or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, £5,000 for a child) are also exempt. In order for the above gifts to qualify, the wedding must happen and therefore in the current circumstances, if anyone has made a gift under this heading and the wedding has not been able to take place the gift would not be exempt but potentially exempt.
You can use more than one of these exemptions on the same person – for example, you could give your grandchild a gift for her birthday and also for his or her wedding in the same tax year.
Annual exempt gifts exemption
An individual can make a gift (or gifts) totalling no more than £3,000 to an individual in a tax year and provided that sum is not exceeded the gift(s) is/are exempt.
The good news about this type of gift is that unused allowance from a previous year can be carried forward for one year. Therefore, in the current environment, for a person who has not used this allowance in the tax year 2019/20 or 2020/21, an exempt gift of £6,000 can be made.
Let’s suppose a family has two children and neither parent has used their annual allowances for the two tax years above. Each parent can now make a gift of £6,000 in the current year, so £12,000 can be passed to the children.
Gifts out of income
Another very useful way to benefit children or maybe even grandchildren is to make a gift out of an individual’s surplus net income of the tax year. Provided they qualify, the gifts are exempt from IHT. UK tax legislation sets out specific conditions that must be met in order for a gift to qualify:
- The gift formed part of your normal expenditure
HMRC look for a regular pattern of payments and the factors that may be taken into account include the frequency and amounts of the gifts, the nature of gifts, the identity of the recipient and reason for the gift.
- The gift was made out of income
You should be able to demonstrate that the gift was made from surplus net income which ideally arose in the year in which the gift was made, before considering earlier years.
- After the gift you were left with sufficient income to maintain your normal standard of living
This is a subjective test but preparing an analysis of income and expenditure each year is the best way to demonstrate this. As income is likely to be lower than usual in the current year, you will need to bear this in mind. As a general rule the amount of surplus is considered on a year on year basis so a one year dip may not be problematic but should not be overlooked either.
Although there must be some regular pattern about the giving, the amount does not need to be fixed. So, it can increased or decreased depending on the donor’s own needs in a given year. This could be particularly helpful in times where everyone is facing uncertainty of income. You could set up a regular pattern of giving and simply adjust the amounts to suit your own affordability over time.
Potentially exempt transfers (PETs)
A PET is a gift of unlimited value to another individual and which becomes exempt from IHT once the donor has survived a full seven years from the date the gift is made. If the donor does dies within seven years of the date of the gift there will be some tax relief on an increasing scale depending on how many years have been survived.
Inheritance tax is charged at 40% on gifts made within 3 years of the donor’s death.
Gifts made between year 3 and 7 years before death are taxed on a sliding scale known as ‘taper relief’.
|Years between gift and death||Tax paid|
|less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
Depending on the age, health and affordability of the donor, PETs can provide a real opportunity to give significant financial assistance to someone who needs it whilst potentially removing significant value from the donor’s estate over time.
Gifts to charities
This is also a good time to consider making a gift to your favourite charities who will also be in need of additional support. Giving to charities can be in the form of cash or qualifying assets. The most common is cash gifts.
The donor makes a cash gift to the charity and receives tax relief by doing so by reducing his own income tax liability.
Tom is a higher rate taxpayer and makes a cash gift of £10,000 to a charity under the Gift Aid scheme.
Gift Aid donations are deemed to be made net of 20% basic rate tax, so the charity can reclaim an additional £2,500 from HMRC. This £2,500 is assumed to be tax Tom has already paid to HMRC. Tom therefore receives 20% tax relief at source as the charity has received £12,500 but it has only cost him £10,000.
|Add: Gift Aid||£2,500|
|Total received by the charity||£12,500|
Higher rate and additional rate taxpayers can also claim additional tax relief. As Tom is a higher rate taxpayer, he will also get an extra 20% of tax relief on the gross donation of £12,500, i.e. tax relief of an additional £2,500.
The cost to Tom is summarised below:
|Total received by the charity||£12,500|
|Less: tax relief through Gift Aid||(£2,500)|
|Less: higher rate tax relief||(£2,500)|
|Cost to Tom||£7,500|
It is possible for a gift in the current year to be “carried back” so the tax relief is obtained earlier positively assisting the donor’s cash flow.
An individual can also support a charity after death by leaving cash or assets to a charity in his or her Will (a ‘charitable legacy’).
The charitable legacy is fully exempt from Inheritance tax and will therefore reduce the value of the taxable estate and the amount of tax payable on the estate.
In some instances, a substantial charitable legacy can also reduce the rate of tax charged on the taxable estate from 40% to 36%. This lower rate of tax will apply to an estate if at least 10% of the “baseline amount” has been left to a charity. The “baseline amount” is broadly the value of the estate after deducing all available reliefs and exemptions and the nil rate band but excluding the charitable legacy itself.
A formula clause for the provision to the charity can be included in the Will in order to ensure that the 10% test is met and the 36% rate of tax is secured. If you find yourself dealing with an estate where the Will is not in this format a variation of the Will can be considered.
The purpose of this article is to explain the impact of making gifts in a practical and helpful way and highlight the tax issues to bear in mind. If you would like to discuss the scope of tax efficient gifting during this difficult time please speak to a member of the private client tax team at Mercer & Hole.