How gifting from income can reduce your estates IHT burden
Ok, I accept not everyone has “more income than they need”. However I see the situation more often than you might expect, particularly in cases where the “older generation” remains on the payroll of the family company, or indeed as a partner in the family business while at the same time having income from their own investments and pension.
The dilemma in this situation is that if that excess income is retained it adds to that person’s eventual IHT problem, being either taxable on death or the subject of a gift of capital during lifetime which, as a potentially exempt transfer, needs the donor to survive for the full 7 years after the gift is made before it falls out of their estate.
What is often overlooked is that if the individual had decided to make regular gifts of some or all of that surplus income, those gifts would be completely exempt from IHT; the 7 year rule would not apply to those gifts. Also, the gifts out of income rule takes priority over other exemptions, such as the £3,000 annual exemption, which would remain available to use for gifts out of capital.
This is an extremely powerful tax saving tool for those who are able to take advantage of it. Aside from there being no requirement to survive for 7 years after each gift if the exemption applies, in the event that for some reason a gift exceeded the amount of surplus income available, it is only that excess that would be subject to the 7 year rule to become exempt – not the entire gift.
Additionally there is, in theory no limit. I have seen individuals taking advantage of this to the tune of a few thousand pounds a year, and others successfully taking many tens of thousands a year out of the IHT net.
In order to meet the exemption the gifts must meet 3 requirements, they must:
- Be part of the normal expenditure of the transferor
- Be made out of their income
- Leave sufficient income for the transferor to retain their usual standard of living.
Points 2 and 3 are essentially arithmetic tests. Meeting point 1 requires some evidence and is most easily met where there is evidence of a past regularity of the gift – i.e. in each of the ten years prior to death, the individual had been gifting away a proportion of their excess income. The sooner you start, therefore, the more likely you are to be able to establish such a position.
However, gifts made over a relatively short period can qualify if there is evidence that there was an intention to continue making the gifts – such as an instruction to accountants/ solicitors, or letters passing to the recipients stating that the gifts are part of an intention to make further such gifts in future years.
Little used, the exemption available for making regular gifts from income should at least be considered by anyone faced with the possibility of having ongoing income of more than they are likely to require – whether that be a few thousand pounds a year or much larger sums.
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