Even if you are aware of the Seven Year Rule, you may still be mistaking your exposure without expert advice.

Inheritance Tax & Lifetime GiftsInheritance Tax has been in the news this month with the changes to allowances announced in George Osborne’s summer budget (for more detail on the new rules, download our free guide here).

But one thing that hasn’t changed is the legislation on Lifetime Gifts and Taper Relief.

You may be aware of Taper Relief and have heard of the ‘7 Year Rule’, but do you know a Potentially Exempt Transfer from a Chargeable Lifetime Transfer; a Bare Trust from a Protective Trust? Do you know how you may accidentally trigger the ’14 Year Rule’?

Are you clear on the difference between a reduction in the amount of the gift taxed, and relief on the full tax due?

At any time, you can call Just Wills and Legal Services for a free consultation with one of our expert advisors, but in the meantime here are some points for you to consider.

What is Taper Relief?

With the right advice and careful estate planning, gifts that you give prior to your death have the potential to significantly reduce your loved ones’ exposure to Inheritance Tax.

But there are strict rules governing what, when and how much you can give before you die, without that gift being counted as part of your estate after death. The most important and perhaps most misunderstood of these are the rules on Taper Relief.

Some gifts you make within your lifetime may be exempt from Inheritance Tax or at least may be eligible for a reduction on the tax payable. These are known as Potentially Exempt Transfers. The key word here is Potentially.

If you give a gift over your annual allowance of £3000 and survive for a further seven years, then that gift will not be counted as part of your estate on death and will not be subject to Inheritance Tax. That’s the potential.

However, should you die within seven years of bestowing a gift, then the full amount of the gift will be counted as part of your estate. If this takes your estate over the current threshold value of £325,000, then your whole estate will be eligible to pay IHT on the amount over the threshold at 40%.

The amount of tax payable is not static over the seven years prior to your death. Rather it is reduced according to a sliding scale dependant on the passage of time from the giving of the gift to your death.

So it pays to plan ahead.

Reduction of Gift versus Relief on Tax Payable

One of the most common misconceptions about Taper Relief is that the ‘tapering’ refers to a reduction in the amount of the original gift that will count as part of the estate. This is not the case. If you gift £100,000 five years prior to your death, then £100,000 will count as part of your assets on your death (potentially minus two years of your annual tax-free gift allowance of £3000).

The tapered relief applies not to the amount counted against your non-taxable threshold, but against the 40% Inheritance Tax owed one your entire estate has been assessed.

Also, Transfers (including Lifetime Gifts and the Transfer of your estate on death) will be assessed for IHT chronologically, so Lifetime Gifts that fall under the £325,000 threshold may actually effectively increase the tax liability to be shared among your benefactors if you decide to give some loved ones their inheritance ‘early’.

Josie’s Story*

In 2010, Mr Smith (a single father) decided to give his daughter Josie £400,000 to help her to buy a new home after her divorce. Unfortunately Mr Smith passed away in 2014 – four years after the original gift or Transfer.

The whole of the £400,000 was counted as part of Mr Smith’s estate. As the gift to Josie was the first Transfer made from the estate, it was assessed first. The amount over the entire estate threshold of £325,000 was £75,000.

This £75,000 was initially taxed at 40%. The tax owed was £30,000!

Then Taper Relief was applied to the tax owed (to the £30,000). A reduction of 40% (it being just over four years from when the gift was given, to Mr Smith’s death) reduced the tax payable to £18,000. This tax must be paid by Josie.

The estate as a whole has now used up its Nil Rate Band (non-taxable allowance) and the remaining estate will be taxed at the full 40% rate, to be paid before the assets can be divided between Josie’s brothers and sisters.

*Although this example is based real events, no real client details have been used.

The 7 Year Rule and the 14 Year Rule

One element of the rules around Lifetime Gifts that many people are unaware of is that the seven year clock can be ‘reset’ with every gift (over your annual allowance) given before the seven year period has expired on previous gifts.

For example, if Mr Smith gave Josie the £400,000 gift in 2010, but then gave a further gift (say £100,000) to Josie’s brother, Jim, in 2012, then the ‘clock’ on Josie’s gift is reset to the point that Jim receives his gift.

As Jim’s gift was received less than three years before Mr Smith’s death, the tax on Josie’s gift now received no relief under the ‘Taper Relief’ rules.

So the key points for you to think about before discussing your will and estate planning with a qualified advisor:

  • If you make a large gift to a loved one prior to your death, are you exposing them to a large tax bill?
  • Do you know if your planned gift qualifies as a Potentially Exempt Transfer?
  • If you gift to one member of your family, how does this affect other beneficiaries of your estate after your death? Are they prepared for this?
  • Does your estate plan take account of what will happen if you die within seven years of any gift you have already made?
  • Might you have inadvertently ‘reset the clock’ on your expected Taper Relief?

If you would like expert advice on protecting your estate from Inheritance Tax, legally and safely, book a FREE consultation with one of our qualified advisors.

If you’d like to book a free consultation with one of our legal experts, book online or call 01342 477 102 and quote ‘Taper Relief Blog’.

This article is for general information only and does not constitute legal advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.