Frank O'Donnell

There is much confusion surrounding Inheritance Tax gifting allowances and believe that if they gift more than the £3,000 annual allowance they or their beneficiaries will run into tax problems. This can often lead to under use of one of the most helpful allowances for many people; the regular gifting from income allowance.

For IHT purposes the taxman makes a clear distinction between gifts out of capital and gifts out of income. Gifts from capital that will be immediately outside of the Estate are quite small and consist of the £3k mentioned above. Larger gifts of capital are allowed but will be generally treated as a Potentially Exempt Transfer and so will be out of the donor’s Estate on their survival after seven years from the gift.

Gifts that are made out of income, providing they are both regular and do not restrict the donor’s life style are treated as immediately outside of the Estate, however large. This allowance is little used and poorly understood, compared to the £3,000 allowance and has the potential to be much more valuable.

There are no tax implications on making the gifts at the time they are made. It is important in order to be able to rely on the exemption at a later stage, the donor keeps good records, available to their executors who will need to document that the gifts are able to fall under this allowance.

The records should consist of bank statements detailing the gifts, along with annual completion of a simple note of total living expenditure and income and a note of the available difference which is the maximum that can be treated as immediately outside of the Estate for will purposes. The will Estate record sheet can be found here.

Income can be from any source, such as interest, dividends, pension, rental or earned income. However income from investment life assurance bonds is not treated as income because it is generally for tax purposes treated as a repayment of capital.

If the donor ends up gifting more than their excess income in a year then it simply means that the excess is effectively a gift from their capital and so if it does not fall under one of the gifts from capital allowances to be immediately outside of the Estate then it will usually be treated as a potentially exempt transfer.

The person in receipt of the gift does not have to declare it for tax purposes, but could in practice be required to meet inheritance tax due on it, in the event that the donor’s Estate in due course was unable to meet its will liabilities.

In order for the gift to be regular, which it needs to be to claim this exemption, ideally establish monthly gifts. This is the quickest way to establish regularity. Annual payments are fine but rely on the donor making at least two or declaring their intention to do so, in order for the Executors to argue that the gifts were regular.

Are you baffled by IHT or would like to know more about how you can pass on your money effectively, please contact me on 0131 331 4191 or email me at info@p3wealth.co.uk to talk through your situation.