19th May 2023Inheritance Tax – HMRC and the 7-year rule
When it comes to Inheritance Tax (IHT), did you know that there isn’t any tax due on outright gifts if you survive for 7 years after giving them? This is a well-known tax exemption called the 7-year rule.
Daniel Tomassen, Senior Manager, Private Client Department at HW Fisher explains: “While the 7-year rule sounds simple, there are a number of common mistakes that people make and nuances that you need to be aware of. With HMRC bringing in a record amount of income from Inheritance Tax, now is the time to make sure you are clued up on the rules around gifting.”
What is the 7-year rule?
- Typically, an individual who makes a gift in their lifetime (which is not covered by a relief such as the annual exemption of £3,000 or deemed to be out of surplus income) is known as having made a potentially exempt transfer.
- Should the individual survive 7 years from the date of the gift then the amount will fall outside of their estate for Inheritance Tax purposes.
- Should the individual pass away within 7 years of the gift then the Inheritance Tax due on the gift may be subject to a lower rate. The reduced rate of IHT depends on the number of years since the date of the gift. Below is a table of the reduced rates:
|Time between the date the gift was made and the date of death
||Inheritance Tax due
|Within 3 years
|3 to 4 years
|4 to 5 years
|5 to 6 years
|6 to 7 years
|7 years or more
What common mistakes do people make?
- If an individual passes away then the reduced Inheritance Tax rates in the table above only apply to potentially exempt transfers to the extent that the gift amounts exceed the nil rate band – typically £325,000. This is because the gifts are deemed to utilise the nil rate band first before the remainder of the deceased’s estate.
- If you are gifting assets other than cash, then consideration needs to be made with the interaction of other taxes such as Capital Gains Tax and Stamp Duty Land Tax. For example, if you gift a buy-to-let property then typically the proceeds are deemed to be the market value and the donor may therefore be subject to Capital Gains Tax on the capital gain arising.
Three ways to avoid being caught out
- Keeping things simple is the name of the game! If a married couple is considering making a gift, consideration should be made as to whether just one of them should make the gift. Typically you see the spouse who is in better health or younger making the gifts as they are more likely to survive 7 years.
- Alternatively, to spread the risk then they may decide to each make a gift of 50%. This way the chances of at least one of the spouses surviving 7 years is higher and therefore more likely that at least 50% of the total gifted amount is likely to fall out at least one of their estates for Inheritance Tax purposes.
- Consideration should be made as to whether a ‘gift inter vivos’ insurance policy should be taken out. For an annual premium the policy will cover the Inheritance Tax payable on the gift should they not survive 7 years. This provides peace of mind to the executors of the estate who may not have sufficient liquidity to settle the Inheritance Tax bill on the gifts.
Daniel adds: “Keeping a clear record of gifts made can make life easier for the individuals dealing with the estate and calculating the Inheritance Tax payable. The deadline for HMRC enquiries for Inheritance Tax is significant and therefore good records can ensure the executors pay the correct amount of Inheritance Tax and minimise the chances of late payment interest and penalties being levied by HMRC.”
If you would like to discuss specific circumstances, please get in touch