June 1st 2017

When it comes to making gifts, timing is the difference between paying Inheritance Tax or not.

Making gifts, especially if they are sizeable, usually reduces the potential Inheritance Tax bill on your estate as long as you survive seven years. But there are some rules that can mean that this won’t always be achieved. Kenny Logan takes a closer look at the traps that should you look out for.

IHT is avoidable?
Inheritance Tax (IHT) has been described as a wholly avoidable tax and whilst this statement is undoubtedly an exaggeration, good planning can dramatically reduce it. However, one way or another, this does mean giving away your wealth. But in common with most tax planning there are traps if you don’t get it right, the interaction of potentially exempt and chargeable lifetime transfers (PETs and CLTs) is one trap that is often overlooked.

Are gifts liable to IHT?
A gift from one person to another is a PET and IHT isn’t payable at the time that it is made. However, it becomes chargeable to IHT if the giver dies in the seven years following the gift.

On the other hand, a gift to a trust which beneficiaries don’t have an immediate right to is a CLT, as is a gift to a company in which you’re not the only shareholder. If within a seven year period, all CLT’s add up to more than the IHT nil rate band (£325,000 for 2017/18) tax is payable, usually within several months.

Joined-up gifts
It’s a common misconception that after seven years a PET will have no effect on IHT payable when you die. In fact, 14 years might need to pass because:

A PET can increase the IHT payable on a later CLT if the giver dies within seven years of the PET.
A CLT made in the seven years before a PET can increase the IHT payable if you die within seven years of making the PET.
What these tricky rules boil down to is that whenever you make a combination of PET’s and CLT’s you run the risk of increasing the IHT payable whichever order you make them in.

In 2010, Peter gave his daughter Jane a property worth £250,000, this counted as a PET. When Peter died in 2016, Jane didn’t expect IHT to be payable on the PET even though less than seven years had passed since the gift, because the value of the PET was less than the nil rate band. However, what Jane didn’t know was that as part of his IHT planning, Peter put £200,000 into a discretionary trust for her in 2005. As result she was liable to IHT of £10,000 on the PET.

Tip. If a PET has been made and there’s a high risk of the person who made the gift dying within seven years, they should avoid making a subsequent CLT. But once seven years have passed a CLT can be made without risking a higher IHT bill.

Tip. If you’ve made a CLT don’t make a PET within seven years. Once the seven years are up you can make a PET or another CLT.

In conclusion
The overall rule of thumb is to avoid making CLT’s or PET’s within seven years of each other. Nevertheless, if you’re IHT planning later in life it’s better to make a gift than not at all, at least that way the seven year period is started.

Lifetime gifts that are subject to Inheritance Tax such as gifts to trusts and potentially exempt transfers (gifts between individuals) that are made within seven years of each other can increase the IHT payable when you die. Therefore you should allow seven or more years between such gifts, especially if they are of high value.

As you will see and already know, IHT planning is complex, for help and expert advice do remember that you can contact the team at JRW at any time.  

JRW Chartered accountants in Edinburgh, Galashiels, Hawick, Langholm and Peebles.