This is one of a number of explanatory articles, part of a set copied under licence from H M Revenue & Customs website:
Introduction Is Inheritance Tax due?
Calculating Inheritance Tax
Valuing assets
Responsibilities of personal representatives
Business relief and businesses
Discretionary trusts
Deceased left no will
Pensions
Agricultural relief
Deceased's liabilities
Foreign aspects
Joint property
Penalties
Settled property
Woodlands
Probate
Alter Inheritance tax
Gifts
Excepted estates
Paying IHT
Thresholds and Interest
Introduction
This guide is designed to help our customers to obtain a grant of representation, complete an account of the deceased's estate, and pay any inheritance tax (IHT) which may be due.
It also gives advice about lifetime gifts and the taxation of discretionary trusts.
This article specifically addresses gifts from various people and whether the receiver will have to pay tax on them.
The proposals in the Finance Bill 2006 affect the meaning in this article regarding:
- gifts into certain kinds of trusts
- the tax treatment of trusts, known as interest in possession trusts, in which the beneficiaries have a right to benefits
- the ending of an interest in possession during a beneficiary's lifetime
- the treatment of funds in alternatively secured pensions on death.
This article will be updated as necessary when the Finance Bill is enacted.
If I make a gift, will any inheritance tax (IHT) be due in my lifetime?
Usually not. If you make an outright gift to someone during your lifetime it is a potentially exempt transfer and will only become chargeable to inheritance tax if you die within seven years of making the gift.
However, if you make a gift to a company or to a discretionary trust the gift is immediately chargeable and you may have to pay some tax in your lifetime if the total value of those gifts exceeds the inheritance tax threshold.
If I make a gift, will any IHT be due when I die?
When you die, all the potentially exempt transfers you have made in the seven years before death become chargeable transfers. They are all added together to work out whether any inheritance tax is payable. Any immediately chargeable gifts you have made in those seven years are also taken into account.
At the date of your death if the total value of the gifts you have made:
- is more than the taxable threshold, there will be some inheritance tax to pay on the gifts;
- is less than the taxable threshold but added to your assets at death the total comes to more than that threshold, there will some inheritance tax to pay on your assets;
- is added to your assets at death and is still below the taxable threshold, there will be no inheritance tax to pay.
Are there any exemptions from IHT?
Yes, some gifts are exempt from IHT.
Can I carry forward any unused annual exemptions?
Yes. If the total value of gifts in any one tax year is less than £3,000 any surplus can be carried forward to the next tax year but no further.
What is a gift with reservation?
A gift which is not fully given away is known as a gift with reservation of benefit.
Where gifts with reservation were made on or after 18 March 1986, we can include the assets as part of your estate but there is no seven year limit as there is for outright gifts.
A gift may begin as a gift with reservation but some time later the reservation may cease.
Example
If you give your house to your child but continue to live there rent free, that would be a gift with reservation. If after two years you start to pay a market rent for living in the house, the reservation ceases when you first pay the rent. The gift then becomes an outright gift at that point and the seven year period runs from the date the reservation ceased.
Or a gift may start as an outright gift and then become a gift with reservation.
Example
If you give your house to your child and continue to live there but pay full market rent, there is no reservation. If over time you stop paying rent or the rent does not increase, so it is no longer market rent, a reservation will occur at the time the rent stops or ceases to be market rent.
There is guidance on the internet about pre-owned assets, which may be of interest to you if you are receiving a benefit from an asset you previously owned.
How do I value a gift for IHT?
The value of a gift for inheritance tax is the amount of the loss to your estate. If you make a cash gift, the loss is the same value as the gift. But this is not the case with all gifts.
Example
John owns a pair of Ming vases. The pair is worth £1million, but a single vase is worth only £300,000. John gives one of the vases to his daughter. The gift, for the purposes of inheritance tax, is not simply the £300,000 vase. Before the gift, John's estate included the pair of vases worth £1million. Afterwards he owned one vase worth £300,000. The value of the gift for inheritance tax is £700,000 (£1million less £300,000). This shows the 'loss to John's estate'.
A similar principle applies to the transfer of shares in a company, which results in the donor losing overall control of the company. The value of the retained shares is usually much lower than that of the original holding, even if only a few shares have actually been given away.
What is the rate of tax due on lifetime gifts?
If you make an immediately chargeable transfer you will pay inheritance tax on the amount exceeding the taxable threshold at the rate of:
- 20% in your lifetime;
- 40% when you die
All immediately chargeable transfers made in the 7 years preceding the transfer will be added together to determine the amount of tax due.
If you make an immediately chargeable transfer and also agree to pay the tax on that transfer, then the value of the gift will be grossed-up to determine the full value of the gift. That is, the amount given, plus the tax on that amount.
If you make an immediately chargeable transfer and die within seven years, then, if the chargeable value of the gift is above the threshold at your date of death, tax will be due at 40% on the amount exceeding the taxable threshold. A credit will be given for the tax previously paid at 20%.
Example
Alice made a gift of £300,000 cash to a discretionary trust on 6 April 2004.
transfer on 6 April 2004 of £300,000
less threshold on 6 April 2004 of £263,000
Taxable amount equals £37,000
£37,000 X 20% = £7,400 IHT due
Example
If Alice agreed to pay the tax on the transfer, instead of the tax being paid out of the discretionary trust fund, then the value of the gift will actually equal the gift plus the tax on the gift. The gift will have to be grossed-up to include the tax paid.
The grossed-up tax is
- £7,400 x 5/4 = £9,250
The gift of £300,000 plus the tax due on the £300,000 is therefore equal to a gift of £309,250.
"grossed-up" gift of £309,250
less threshold on 6 April 2004 of £263,000
Total was £46,250
£46,250 x 20% = £9,250 IHT due
How will IHT on gifts be worked out when I die?
We look back seven years from your death. The chargeable value of gifts in that period is added to the total value of your estate at death. The gifts will use up all or part of the inheritance tax threshold first.
Example
In May 1997 Richard, a widower, made a cash gift of £153,000 to his son. The chargeable value of the gift was £150,000, after deducting the £3,000 annual exemption. In June 2002, when the taxable threshold is £250,000, Richard died leaving an estate worth £500,000. As less than seven years has passed since Richard made the gift, the chargeable value of the gift is added to Richard's estate.
The inheritance tax payable on £400,000 at 40% is £160,000. The tax is payable by Richard's legal personal representatives, normally out of estate funds.
No tax is payable on the gift itself, because it does not exceed the taxable threshold. However, the existence of the gift means that consequently more of the estate at death is taxed at the 40% rate because the gift uses up some of the available threshold that is tax free.
If the gift had been made in 1993, then it would have been made more than seven years before Richard's death. It would therefore be an exempt transfer and we would ignore it for inheritance tax purposes. Inheritance tax would only have been payable on Richard's estate at death. The tax payable would have been £ 100,000 (£500,000 less £250,000 at 40%).
What happens if the gifts I have made are more than the IHT threshold?
There are three steps to follow
Step 1 - place the gifts in the order that they were made, starting with the oldest and moving towards the date of death.
Step 2 - deduct all the exemptions and reliefs available against each gift, to find the chargeable value of each gift
Step 3 - add the chargeable value of each gift together, beginning with the oldest, adding this to the second oldest and so on.
At some point, the running total of the gifts will exceed the inheritance taxable threshold at the date of death. After this point, inheritance tax at 40% is payable on the chargeable value of the gifts
Example
Kate died in October 2002 having an estate at her death worth £750,000. In the seven years before her death, she made a number of gifts.
Date Value of gift
January 2001 £100,000
June 1999 £50,000
June 1996 £3,000
May 1996 £3,000
October 1995 £140,000
November 1995 £100,000
At her death, the taxable threshold is £250,000
Step 1 - place the gifts in the order that they were made, starting with the oldest and moving towards the date of death.
Step 2 - deduct exemptions and reliefs. The only appropriate exemption in this case is the annual exemption.
Date Value of gift Exemptions value Chargeable total Running total
October 1995 140,000 6,000* 134,000 134,000
Nov 1995 100,000 Nil 100,000 234,000
May 1996 3,000 3,000 Nil 234,000
June 1996 3,000 Nil 3,000 237,000
June 1999 50,000 6,000* 44,000 281,000
January 2001 100,000 3,000 97,000 378,000
Note: *See 'Can I carry forward any unused annual exemptions?'.
Step 3 - add the chargeable value of each gift together. The running total shows how the total of the gifts mounts up. The June 1999 gift exceeds the taxable threshold at death (£250,000) and so tax will be payable on the part of its value which is more than £250,000.
The tax payable will be £12,400 (£281,000 - £250,000 = £31,000 at 40%).
The whole chargeable value of the January 2001 gift exceeds the threshold, so the tax payable will be £38,800 (£97,000 at 40%).
The tax is payable by the person who received the gift.
Is there any relief available on the tax paid on gifts?
Yes. There is a special relief known as taper relief when the total chargeable value of all the gifts made between three and seven years before death exceeds the inheritance tax threshold at death. Use this link to find out how to calculate taper relief.
Who is liable for the tax on gifts?
Depending on the precise circumstances different people can be liable for the payment of inheritance tax including:
- the donor (in which case the amount of the gift will be increased by the amount of the tax);
- the donee, or;
- legal personal representatives of the estate.
If there is any difficulty in obtaining payment from one source, we can look to the others for payment
Who is responsible for telling HM Revenue & Customs about gifts?
You should fill in form IHT100 to tell us about gifts (other than exempt or potentially exempt gifts). If you have:
- made a gift to a company or to a discretionary trust so that an immediate charge to inheritance tax arises, you should tell us about it within one year of making the gift;
- received an outright gift from someone and they have died within seven years of making the gift, you should tell us about it within one year of death;
- received a gift with reservation of benefit from someone and they die after making the gift, you should tell us about it within one year of death.
Although you do not have to tell us about potentially exempt gifts or gifts with reservation of benefit at the time they are made, all gifts that are chargeable to inheritance tax because of the donor's death must be reported to us after the donor has died.
The personal representatives will be responsible for deciding whether they need to deliver an Inland Revenue Account for an estate on death. If an Account is needed, they must provide full details of all gifts made within the seven years of the date of death.
You can help your personal representatives to deliver a full and proper Account by keeping a record of all gifts you make.
Will I have to pay capital gains tax (CGT) if I make a gift?
If you make a gift of an asset to another person or a company or trust, you will be treated as if you had sold the asset at its market value. Capital gains tax will be charged on any increase in the value of the asset since you acquired it.
However, you may be able to claim gift hold-over relief (i.e. defer the charge) if the asset is a:
- business asset;
- certain shares or securities, or;
- agricultural land.
You may also be able to claim hold-over relief if the disposal is an immediately chargeable transfer for inheritance tax purposes, but not if it is a potentially exempt transfer.
Are any gifts exempt from CGT?
A gift you make to your spouse or civil partner when you are living together is not normally liable to capital gains tax. See our articles on Capital Gains tax for more information.
Are gifts of all assets liable to capital gains tax?
A number of assets are exempt from capital gains tax, including
- gifts of cash sterling;
- motor cars
- personal tangible assets worth £6,000 or less, and;
- UK Government stocks and savings certificates. | 
