The Overlooked Inheritance Tax Exemption

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FREQUENTLY ASKED BUSINESS QUESTION

I am considering making regular gifts to my adult children. Do I have to survive each of these gifts by 7 years in order for them to fall outside my estate for inheritance tax purposes or is there an Inheritance Tax Exemption for which the 7 year rule does not apply?

TAX TIP:

Which Gifts Apply for Inheritance Tax Exemption?

A gift by one UK taxpayer to another (other than a spouse which is exempt) is normally categorised as a Potentially Exempt Transfer (PET). A PET ensures that the gift falls out of their estate for inheritance tax once the donor survives the gift by seven years. 

However, there are a number of Small Gift Inheritance Tax Exemptions which enable such gifts not to be considered as PET’s and therefore the 7 year rule does not apply:

• The minor gift allowances that are £250 per annum per person
• An annual exemption of £3,000 per annum
• If the previous year’s exemption is unused it can be carried forward to enable you to make £6,000 of gifts in one year
• On the occasion of marriage, there is also the ability to make a gift of up to £1,000 per person which increases to £2,500 for a grandchild or great-grandchild and up to £5,000 for a child.

The Valuable Overlooked Inheritance Tax Exemption

“Normal Expenditure Out of Income” (NEOOI) | What is it?

An often overlooked Inheritance Tax Exemption is the “Normal Expenditure Out of Income” exemption (NEOOI). This is a very valuable inheritance tax exemption because the gift or “disposition” is exempt. Therefore, it is irrelevant whether or not the donor survives the gift by seven years.

Qualifying Conditions for Normal Expenditure Out of Income to Apply

For the NEOOI inheritance tax exemption to apply, it is essential to show that the disposition meets 3 conditions:

 1. The gift forms part of the donor’s normal expenditure

2. The gift was made out of income after taking one year with another

3. The gift leaves the donor with enough income to maintain their normal standard of living.

“Normal” does not normally mean regular or annual, however, gifts made on a regular basis are more likely to pass the normality test.

There is no set time span to establish a pattern of giving, however, HMRC normally look over a 4 year period when considering gifting patterns. It is also advisable that the gifts made are of a similar size. It can be argued that gifts may vary in size if the donor has a fluctuating income. If the donor has to resort to their capital to meet their normal living expenses then the gifts will not qualify for the inheritance tax exemption.

Does my Gift Qualify for Inheritance Tax Exemption? | The 5 Factor Test

HMRC will typically consider 5 key factors when deciding whether a gift is normal and qualifies for exemption. These factors include:

1. The frequency of the gift
2. Nature of the gift
3. Amount of the gift
4. Who the recipients are
5. The reason for the gift

How to Claim

To claim this exemption, it is important to keep detailed records of the gifts, income, and expenditure of the donor.

HMRC provide a useful IHT 403 form that can be accessed via their website. The form provides a schedule that can be kept over a number of years and will act as evidence that the gifts were made as part of normal expenditure out of income. Following death when an estate is being submitted to HMRC by a Solicitor, the IHT 403 form will be populated and submitted as part of the overall IHT400 return.

Here to Help

As always, the team at FPM are here to help with all your finance and tax queries. For more information and assistance on Inheritance Tax, please contact our Tax Team.