IHT – Exemptions and Reliefs

Certain gifts may be free of IHT. Exemptions may apply to lifetime gifts only or in certain cases they may also apply to gifts made on death.

Lifetime Gifts Only

Annual Gift Exemption

For gifts up to £3,000 each tax year can be carried forward for one tax year only. The current year’s exemption will be used before any amount carried forward (a couple who have not used the exemption in the current or previous tax year could make exempt gifts of £12,000) Cannot be combined with the small gifts exemption to make an IHT free gift of £3,250.

Small Gift Exemption

Gifts of up to £250 can be made to any number of people in the same tax year but must be made outright and not for example into a trust. If the total of gifts made in the tax year to the same person is more than £250, this exemption cannot apply at all.

Normal Expenditure out of Income Exemption

The normal expenditure out of income exemption allows the donor to make a series of IHT effective gifts from surplus income. There is no monetary limit to this exemption so the size of the exempt gift is only limited by the amount of the donor’s surplus income. To qualify for the exemption, the gifts must:

  • form part of normal expenditure (a regular pattern of gifting)
  • be made out of income
  • leave the donor with sufficient income to maintain their usual standard of living

Normal expenditure

The gifts must form part of a habitual pattern of gifting. This can be shown from the history of gifts actually made by the donor. Alternatively, where there is no such history, the exemption may still be claimed where it can be shown that the donor had made a commitment to future gifting.

Income

Gifts must be made from current net income and not capital. Income for the purposes of the exemption does is broadly income received from employment or pension, the natural yield from investments such as interest or dividends (not accumulated income) and income derived from assets such as rental income.

Usual standard of living

After making gifts, the donor should be left with enough income to maintain their usual standard of living. If they have to resort to capital to maintain their lifestyle the exemption may be lost or limited.

The usual standard of living will generally be the standard at the time of making the gift. However, where unexpected circumstances cause a change to their standard of living, for example, unemployment or a sudden requirement for residential care, the exemption may not be lost even if they do have to make future gifts from capital. Also, where unexpected circumstances mean that changes in the donor’s standard of living provide increased surplus income, this too may be gifted using the exemption.

Record keeping

The exemption is claimed following death of the donor by the personal representatives (PRs) completing HMRC form IHT403. It is helpful to the PRs if the donor can keep records of gifts made, with details of their income and expenditure, using the form during their lifetime.

Gifts in consideration of marriage/civil partnership

Usually made before the marriage or civil partnership takes place:

  • Each parent can give £5,000
  • Each grandparent can give £2,500
  • Any other person can give £1,000

Gifts for Education and Maintenance

Lifetime transfers to a current or former spouse or civil partner or a dependent relative for their maintenance are not subject to IHT

Payments for a child’s maintenance, education or training.

Exempt gifts made during lifetime or on death

  • Gifts between UK domiciled spouses and civil partners. Special rules apply if the gift is from a UK domiciled to a non-domiciled spouse.
  • Gifts to charities and political parties
  • Gifts for national benefit, such as to museums, universities, libraries or the National Trust
  • Gifts between spouses and civil partners

Gifts between spouses and civil partners are generally free of IHT provided that the recipient of the gift is UK domiciled or deemed domicile. Unlike the CGT spousal exemption, spouses do not need to be living together at the time of the transfer. The exemption still applies where the parties are separated but continue to be legally married or remain in a registered civil partnership.

Taper Relief

Gifts which are chargeable lifetime transfers (CLTs) or potentially exempt transfers (PETs) may be subject to IHT if the donor dies within seven years of making the gift. Inheritance tax taper relief may reduce the amount of inheritance tax payable on lifetime gifts where:

  • death occurs between three and seven years from the date of the gift, and
  • the value of the gift, when added to any other gifts in the previous seven years, exceeds the nil rate band (NRB) in the year of death,

On death any PETs made within seven years of death will become chargeable transfers and any CLTs made during the same period will be reassessed for IHT. Each chargeable transfer will have its own seven-year cumulation that will determine the amount of nil rate band available to it.

Any lifetime transfers made within the seven years of death will have first use of the NRB (oldest first) before the rest of the estate. For this reason, there will be no taper relief if the total of lifetime gifts is less than the NRB as there will be no tax to relieve. Where IHT is payable on lifetime gifts taper relief may apply based on the following scale:

Example

Mrs Bacon dies on 23 April 2023, leaving an estate worth £500,000. The NRB at date of death is £325,000. In the seven years before her death, she made the outright gifts below. She had already used her annual exemptions in full elsewhere.

Both the December 2016 and January 2017 gifts are within the NRB and therefore no IHT is due. However, the July 2017 gift of £150,000 only has £63,000 of the NRB available and therefore £87,000 of this gift exceeds the NRB, which is subject to an IHT charge at 40%

£87,000×40%+£34,800 IHT due before taper relief is applied

As the gift was made within 5-6 years of death, taper relief of 60% on the IHT payable is due.

Taper relief = £34,800 x 60% = £20,880

Therefore, the revised IHT position is as follows = £34,800 – £20,880 = £13,920 payable by the recipient of the July 2017 gift.