Nearly 2,000 people who believed they had reduced the value of their estates by taking advantage of an Inheritance Tax break, were surprised to see the break stripped away.

On individual estates worth more than £325,000, Inheritance Tax (IHT) is charged at 40%. For married couples this threshold can double.

Further exemptions and allowances can be applied to increase the threshold or taper the IHT rate down from 40%.

One such relief is the seven-year rule, which lets people gift assets in order to reduce the value of their estate, allowing them to pass on more wealth.

However, the Telegraph made a Freedom of Information request and found that, since 2016, 1,830 gifts worth £624 million have been deemed taxable at 40%.

The overwhelming majority of these ‘gifts gone wrong' related to property. A further 13% were cash gifts, with shares and securities accounting for 8% and the remainder being classed as "other assets".

If HMRC discovers an individual continues to benefit from an asset they had given away, it is known as a ‘gift with reservation of benefit'.

An obvious example of this is where someone gifts a property to a descendant, yet continues to live in, and therefore benefit, from that property.

If this happens and HMRC finds out, the tax break no longer applies and the value of the gift again forms part of the gift-giver's estate for IHT purposes.

The seven-year rule

Gifts of property and other assets can be tax-free if the person making the gift survives for at least seven years after giving away the asset.

Assets include items such as money in a bank, property or land, jewellery, cars, shares, an insurance policy payout and jointly-owned assets.

Should the gift-giver die within those seven years, the gift will be considered part of the estate's value if it exceeds £325,000.

However, if they were to die within three years of making the ‘potential exempt transfer' (PET) of an asset, IHT is charged at the full 40%.

PETs made three to seven years before the gift-giver dies are taxed on a sliding scale, due to taper relief being available, as follows:
 

• 3 to 4 years - 32%
   
• 4 to 5 years - 24%
   
• 5 to 6 years - 16%
   
• 6 to 7 years - 8%.

Gifts gone wrong

Not understanding the gifting rules can put families at risk of being worse off in the long run, especially with rising property prices resulting in more estates being eligible for IHT.

In the case of gifted property, as previously mentioned, should HMRC discover that a gift-giver continues to live in the property without paying rent at market rates or, perhaps, making a token subsidised payment, the gift will still form part of the giver's estate.

For the recipient of the property, the rental payments from the person who made the gift would also be liable to Income Tax at their marginal rate. Furthermore, assuming they already own a main residence, a Capital Gains Tax charge would arise if the recipient were to sell the gifted house.

Others caught out have been those who gift money, but wish to retain control of it. For example, parents who gift money to their children as a loan note (in a bid to retain control if their children-in-law file for divorce and try to run off with the family money) would also fail to be tax-exempt.

Should HMRC look into these affairs and find any discrepancy and continued benefit, the 'gift with reservation of benefit’ will be identified and the executor of the estate will be liable to pay the tax bill after the giver's death.

Establishing an estate planning strategy

A recent study by Schroders found that the majority of families in the UK have no estate planning strategy in place.

The survey of around 1,000 parents over the age of 60, found that 78% of respondents had no estate planning strategy.

A good estate plan can enable individuals to reduce, or even mitigate altogether, any potential IHT liability that may arise for their beneficiaries.

Having a plan in place to handle this efficiently is crucial when it comes to passing wealth on smoothly, avoiding family disputes and managing any tax bill.

We can help

Give us a call today on 01483 205890 to discuss your own circumstances and how we can put together an estate planning strategy for you.