Introduction
The holiday season is a time of joy, generosity, and giving. As Christmas approaches, many of us find ourselves in the spirit of giving, whether it’s through thoughtful presents, donations to charitable causes, or financial gifts to loved ones. However, what many may not be aware of are the potential tax consequences associated with gifting. In the United Kingdom, the rules regarding gifting and inheritance tax (IHT) are quite specific and understanding them can help you ensure that your generosity doesn’t lead to unexpected financial liabilities.
Defining a Gift for IHT Purposes
To comprehend the tax implications of gifting during the Christmas season, it is crucial to understand how the law defines a gift for inheritance tax purposes. In the context of IHT, a gift is any transfer of assets, such as money, property, household or personal possessions or investments made by an individual during their lifetime that reduces the value of their estate. The estate’s value is a key factor in determining whether IHT is payable. A gift also encompasses instances where you incur a loss by selling an item for less than its market value. For instance, if you decide to sell your car to your child at a price below its market worth, the disparity in value will be considered a gift.
Ways to Give Without Inheritance Tax Consequences
- Annual Gift Allowance:
Each UK resident has an annual gift allowance, which allows them to give away a certain amount of money or assets each tax year without incurring inheritance tax. The annual allowance is currently set at £3,000 per person. This means that a couple could jointly give away £6,000 without any IHT consequences. This annual exemption is a valuable tool for individuals to share their wealth with family members and loved ones during the festive season.
- Small Gifts:
Additionally, you can make small gifts of up to £250 per person each tax year without incurring any inheritance tax. These gifts can be made to an unlimited number of individuals, as long as you have not used another allowance for that person, allowing you to spread holiday cheer without worrying about IHT.
- Gifts to Spouses or Civil Partners
When it comes to gifts to spouses or civil partners, the IHT consequences are generally favorable. Gifts between spouses and civil partners are exempt from inheritance tax and there are no limits to the amount that can be transferred between spouses or civil partners.
- Wedding and Civil Partnership Gifts:
Gifts made in connection with weddings or civil partnerships are exempt from inheritance tax, subject to specific limits. You can gift a child up to £5,000, grandchildren or great-grandchildren up to £2,500, and anyone else up to £1,000.
- Charitable Donations:
Making charitable donations is another tax-efficient way to share your holiday spirit. Gifts to registered charities are typically exempt from inheritance tax.
7-Year Rule and Its Implications
One of the key aspects of gifting that individuals should be aware of is the “7-year rule.” When you make a gift and survive for at least seven years, that gift is exempt from inheritance tax. However, if you pass away within seven years of making the gift, it will still be considered part of your estate for IHT purposes. If the value of the gift is below the available Nil Rate Band (currently £325,000) the value of the gift will use up some of the available Nil Rate Band, leaving a reduced sum. If the gift exceeds the available Nil Rate Band, this will create an IHT liability for the recipient of the gift. The tax rate on this gift decreases with time, following a sliding scale, known as “taper relief.” After three years, the tax reduces, and it continues to decrease until after seven years when the gift is entirely exempt from IHT.
Consequences for Your Estate
If you make a gift and pass away within seven years, the value of that gift will be added back to your estate for the purpose of calculating inheritance tax. Depending on the total value of your estate, this could result in additional tax liabilities that your beneficiaries may need to settle from the assets you leave behind.
The Reservation of Benefit Rule
In the UK, the reservation of benefit rule is an essential consideration when making a gift. This rule stipulates that if you give away an asset but continue to benefit from it in some way, the gift may still be considered part of your estate for IHT purposes.
For example, if you gift your home to your children but continue to live in it rent-free, the value of the home might still be included in your estate for IHT calculations. It’s crucial to ensure that there is no “reservation of benefit” if you intend to make a tax-free gift.
In Conclusion
Christmas is a time for giving and it’s essential to understand the tax consequences to ensure your generosity doesn’t lead to unexpected financial burdens for your loved ones. By taking advantage of the various gifting allowances and exemptions, as well as being aware of the 7-year rule, you can navigate the festive season while minimizing your inheritance tax liabilities. Keep in mind that tax laws and regulations often change, so if you would like to obtain gifting advice before Christmas this year, please contact us to speak to a member of our Private Wealth & Inheritance team.
From everyone at Herrington Carmichael, we wish you a happy Christmas and a happy new year.
