Inheritance tax is sometimes described as an optional tax because of the basic principle that if you make an outright gift and survive it by more than seven years, it generally falls outside your death estate on which inheritance tax is charged.
However, it is possible to give away significant amounts without those amounts falling within your death estate even if you die within seven years using the inheritance exemption for gifts made out of excess income. To qualify for exemption gifts must be ‘normal’ expenditure, made out of income and must leave the donor with enough income to maintain their usual standard of living.
Normal expenditure means a ‘regular giving’. This does not need to be a fixed amount on a fixed date to the same person(s) but it should form a regular pattern of gifts to a category of persons (such as grandchildren). HMRC generally considers gifts over a three to four year period is sufficient to qualify a regular giving but a single gift could qualify if there was a clear intention for it to be the first of a series of regular gifts.
Gifts must be made out of post-tax income, not capital. This is generally considered on an annual or bi-annual basis. HMRC considers that accumulated income usually becomes capital after two years.
The donor must maintain their usual standard of living after making the gifts so if they are drawing down on capital to fund their giving, the exemption will not apply.
The key to this relief is in the record keeping. Executors need to record all gifts made within seven years of death and claim the exemption. The Executors will need to prove that the conditions of the exemption are met in the event of challenge by HMRC. HMRC would look to review the deceased’s annual post tax income as well as their annual costs of living so it is recommended to keep detailed records of this.
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Please note that the above is for general information only and does not constitute financial or tax advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation.
