Are Gifts Made from Income Liable for Inheritance Tax?
05 December 2019
If someone makes gifts during their lifetime, it's important that these are fully investigated during Probate as they could affect the Inheritance Tax liability of the Estate. Gifts that the deceased made from their normal income will usually not be liable for Inheritance Tax. In this article, we explain what constitutes a normal gift from income.
The rules around lifetime gifts are complicated. For this reason we would always recommend that you contact a Probate Specialist if you're administering an Estate and you aren't entirely confident in how to deal with lifetime gifts.
In this article, we will provide some general guidance and explain why gifts made from income are unlikely to be liable for Inheritance Tax after death.
Gifts from Income and Inheritance Tax
Certain gifts are exempt from Inheritance Tax, including normal gifts that a person makes from their income. This is the 'normal expenditure out of income' exemption.
For a gift to fall under this exemption and not be liable for Inheritance Tax it must be shown that the gift:
1. Is made as part of the 'normal' expenditure of the person
Normal can mean regular, habitual or usual. The Personal Representatives will need to look for a pattern of giving from the deceased person. There is no set time span over which to check and sometimes the Personal Representatives will have to look over a period of several years to see a pattern. Factors to take into account in looking at any pattern of gifts include the frequency and amounts, the nature of the gifts, the identity of the recipients and the reasons for the gifts.
What is 'normal' is considered on an individual basis and not what is considered normal for the average person. The sort of gifts that may qualify range from birthday and Christmas presents to paying school fees for grandchildren.
2. Is made out of income
Usually gifts covered will involve cash. However, premiums paid on a life policy or mortgage payments made for the benefit of another person can be covered by the exemption. Gifts made from capital and capital assets (e.g. shares or jewelry) are not covered unless the item was purchased specifically from income for the purpose of making the gift.
Income should be current income. Examples include income from employment or pensions, rent from property or dividends/interest. Gifts made from income accumulated over several years will tend to be classed as capital and therefore not covered by the exemption.
3. Leaves the person making the gift with enough income to maintain their normal standard of living
This generally means that the gift must be made out of 'surplus' income. So the Personal Representatives must show that after making the gifts, the deceased person was able to meet their normal living expenses out of their remaining income. A person's normal standard of living is considered on an individual basis. If after making the gifts the person had to use capital to meet their daily living needs then the gift would not qualify.
With our Probate Complete Service we take full responsibility for getting Grant of Probate and dealing with the Legal, Tax (excluding VAT), Property and Estate Administration affairs.
How Does Inheritance Tax Work for Other Gifts?
There are other gifts that can be made that will also be exempt from Inheritance Tax. Firstly, every individual is entitled to an annual exemption of £3,000 per tax year, meaning that gifts made up to this value would not be included in Inheritance Tax calculations after death. The annual exemption can be carried over to the next year if it's not used, meaning that an Estate could be eligible for a £6,000 exemption in any one year providing none of the allowance was used in the previous year.
Small gifts of £250 or less aren't generally liable for Inheritance Tax. Each recipient can only receive one of these gifts per tax year, but there is no limit on how many of these gifts can be given to different recipients. Bear in mind though that if any of the exemptions mentioned below have already been used on another gift to the same person in the same tax year, then Inheritance Tax may be applicable.
Every tax year, an individual is entitled to give away one wedding or civil ceremony gift per recipient. These gifts do have limits applied, which vary depending on the relationship between the donor and the recipient. Children can be given a wedding gift of up to £5,000, grandchildren can be given £2,500 and any other person can be given £1,000.
Payments that are made to help with somebody's living costs are also exempt. So, if payments have been made to an elderly relative or a child under 18 to help them pay their utility bills, for example, then this will not be liable for Inheritance Tax.
Also, any gifts made to spouses, civil partners, charities or political parties are also classed as exempt gifts. There is no limit on the value of gifts that can be given to these recipients (providing the spouse or civil partner lives permanently in the UK).
Any gifts that which fall outside of this scope, and were made in the seven years leading up to the donor's death, could be liable for Inheritance Tax. The value of these gifts will need to be added to the value of the Estate when calculating the Inheritance Tax liability.
For more information on how Inheritance Tax is calculated on lifetime gifts, see Lifetime Gifts in Probate & Inheritance Tax.