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Are you up to speed with the seven-year Inheritance Tax rule?

Inheritance Tax is a complicated subject and gifts are a particular source of confusion.

Whether it’s for a birthday, a wedding, Christmas or any other special occasion, small gifts are commonly exchanged throughout a person’s life.

But few people are aware that large gifts could attract tax should the benefactor die within seven years of the date the gift was made.

Here, David Webb, a Director with Mander Hadley who deals with older client and estate preservation matters, explains why it is important to understand how the seven year rule could affect your estate:

“Under the “annual exemption” rule, you can give away up to £3,000 worth of gifts each tax year (spanning 06 April to 05 April) without them being added to the total value of your estate. Any unused annual exemption can be carried forward, but for one year only,” said David.

“In addition, you can gift a wedding present of up to £1,000 per person (£2,500 for a grandchild or great-grandchild or £5,000 for a child) without attracting tax, as well as make tax-free traditional gifts, such as Christmas or birthday presents, out of your income, providing you can still maintain your standard of living.

“You can also give as many gifts of up to £250 per person per tax year, providing you have not used another exemption on the same person. Any gifts outside of these rules fall under the “seven-year rule”.

“If a gift is made to an individual which is for a greater value than is permitted for exempt gifts, then it is called a Potentially Exempt Transfer (a PET). If the person making the gift survives by 7 years then it becomes exempt.

“If on the other hand the person making the gift, which is classed a PET, dies during the 7 year period then the value of the PET becomes chargeable (and is termed a failed PET) and the value is deducted from the Inheritance Tax Nil Rate Band of £325,000. For example if the failed PET (or if more than one the aggregate of failed PETs) was £100,000 then the Nil Rate Tax Band is reduced to £225,000 and the estate over this would be taxed at 40% (subject to any other exemptions, reliefs and allowances which might be available).

“If the failed PET or PETs exceed the threshold of £325,000 then the excess over and above this is taxed at 40% but might benefit from taper relief.

“Taper relief operates by a reduction of the rate of tax, depending on how long the person making the gift survived into the 7 year period.

“For example, if death occurs less than three years after a gift was made, Inheritance Tax is payable at a rate of 40%. At the other end of the scale, if the gift was made six years prior to death, a reduced rate of only 8% is due.”

David added: “It is also worth bearing in mind that some gifts made to certain trusts and companies will be chargeable lifetime gifts not PETs.

“The amount of the gift in excess of the Nil Rate Band of £325,000 will attract tax of 20% payable immediately, with an extra 20% payable if the person making the gift dies within seven years of making the gift.”

For help and advice with related matters, please get in touch with our expert team.