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Lifetime gifts in probate and inheritance tax
Lifetime gifts must be reported to HM Revenue & Customs (HMRC) accurately in order to avoid penalties.
In order to apply for Probate in England or Wales, the Personal Representative must fully investigate lifetime gifts in order to calculate Inheritance Tax (IHT).
The Personal Representative must also work out whether they can use form IHT205 when applying for Probate, as some gifts may mean that the more extensive form IHT400 is needed.
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What are lifetime gifts?
Lifetime gifts are cash or assets gifted by the deceased person during their lifetime, or some other disposal of an asset which results in a loss to their Estate.
- Mr Smith gives his son £10,000 a year before his death
- Mrs Taylor sells her house to her daughter for £200,000 two years before her death when the market value is £250,000: this amounts to a gift of £50,000. (In this example the gift only applies because the purchaser was related to Mrs Taylor. There would be no gift if the purchaser was not related to Mrs Taylor)
- Mr White has shares in a company that give him control of the company. Mr White sells half of his shares at full market value to a friend resulting in him losing control of the company and reducing the value of the shares he has retained
- Premiums paid on life policies may be treated as lifetime gifts if the policy is in Trust for the benefit of others rather than paying out to the deceased’s Estate on their death.
Since lifetime gifts may need to be added to the Estate (after any available exemptions have been applied) in order to calculate the IHT, it is vital that the Personal Representative investigates these fully and reports them to HMRC accurately in order to avoid penalties.
Types of lifetime gift
There are two types of lifetime gift:
- potentially exempt transfers
- gifts with reservation of benefit
Potentially exempt transfers
Most gifts to individuals will be Potentially Exempt Transfers (PET), which means that if the deceased survives 7 years after making the gift then it will be exempt from Inheritance Tax, no matter what the value is. This is provided that the deceased did not reserve a benefit in, or continue to enjoy, the asset after it had been gifted. See Gifts with Reservation of Benefit below.
Gifts with reservation of benefit
These are gifts where the deceased has given away an asset, at any time, and has continued to receive an income from it or has lived in it (if it is property) or has in any other way enjoyed the use of it. The beneficiary may not have taken full and exclusive ownership of the gifted asset or the deceased may have contributed to the purchase of an asset for them and then benefited from that asset in some way.
If there is a gift with reservation of benefit it will need to be valued as at the date of death and the 7 year rule does not apply. This is very common with the deceased’s residence and other houses, land and buildings, and also with bank and building society accounts.
When considering whether there is a reservation of benefit, consideration should also be given to the law relating to pre-owned assets which is a complex area requiring specialist advice.
If the deceased made a gift of this kind then it must be reported to HMRC on form IHT400.
What are the personal representative’s duties?
In order to determine whether lifetime gifts need to be added to the Estate, the Personal Representative will need to:
Establish whether the deceased owned any assets during their lifetime (either solely or with another person, trust or organisation) but no longer owned them at the date of death
Check whether the deceased ever made any gifts with benefit reserved, and the reservation did not end more than seven years before death
Investigate the period of 7 years before the date of death and, if there are gifts within that period, a further 7 years from the earliest gift; this could mean an investigation extending to 14 years.
Investigating lifetime gifts
A good starting point is the relatives and associates most likely to have received lifetime gifts from the deceased, including gifts for birthdays, Christmas or other religious festivals, and on marriage. Also check whether the deceased paid for anything on someone else’s behalf, such as holidays, bills, or money loaned them which has been waived.
Bank statements should be checked for monies being paid to individuals (or Trusts). HMRC suggest the Personal Representatives initially check the previous 3 years’ bank statements which will be a good indication of the gifting history of the deceased. If there are any withdrawals or transfers which seem unusual in the amount or regularity, then a review of the bank statements for the full 7 years is advisable.
If the deceased’s home address is different to the address in the Will then the Personal Representative should establish what the deceased did with the earlier property to check it was sold and not gifted. Similarly, if an item gifted in the Will doesn’t exist at the date of death then enquiries should be made regarding whether it was sold or gifted in the deceased’s lifetime.
The Personal Representative should check the purchase of any jointly owned property. If the contribution to the purchase of assets, usually a house, was unequal, the Personal Representative needs to ensure that the deceased’s share of the property at death is declared correctly.
For example, if the deceased bought a house with his two children, all owning an equal share, then one third of the purchase monies and costs should have been provided by the deceased. If the deceased paid all legal costs and other expenses relating to the purchase as well as his one third share of the purchase price then two thirds of those costs and expenses could be deemed a lifetime gift to the children.
Lifetime gifts and inheritance tax treatment
The value of any gift with reservation of benefit is added to the Estate value at the date of death and it is the value of the gift at the date of death that is added.
Any Potentially Exempt Transfer (PET) which has failed because the deceased died within 7 years of making it is also added to the Estate value (after exemptions have been applied) though the value to be added is that at the date of the gift.
Taper relief can be applied to Potentially Exempt Transfers (PET) being added to a deceased person’s Estate if the deceased died between 3 and 7 years of making the gift. This relief only applies if the amount of the PET exceeds the Inheritance Tax threshold (nil rate band), currently £325,000.
If the relief applies then it reduces the amount of Inheritance Tax payable on the PET, depending on the number of years the deceased survived after making the gift. For example, Mr Smith gave £350,000 to his son on 14/1/2008. Mr Smith died on 14/04/2011 so he survived the PET by 3 years but died before the 4 year anniversary of making the gift. Taper relief of 20% applies which means that the IHT payable on the gift will be:
Less IHT threshold (£325,000)
IHT at 40% £10,000
Less Taper Relief at 20% (£2,000)
IHT payable £8,000
Inheritance tax exemptions
There are some exemptions that reduce the amount of lifetime gifts to be added to the Estate.
A person can give up to £3,000 away each tax year (from 6th April in one year to the 5th April the following year) during their lifetime, either as a single gift or as several gifts adding up to that amount, and can also use any unused allowance from the previous tax year provided the current tax year’s allowance is used first.
Small gift exemption
Small gifts of up to £250 each can be made to as many individuals as a person wishes in any one tax year provided no other gifts were made to them.
Wedding and civil partnership gifts
Gifts to someone getting married or registering a Civil Partnership are exempt provided they are made on or shortly before the marriage or Civil Partnership registration to one or both parties and are effective on the marriage or Civil Partnership registration occurring. A limit is placed on the amount which can be gifted as follows: up to £5,000 from a parent/step parent; up to £2,500 from a grandparent or remote ancestor; up to £1,000 from anyone else.
Regular gifts made out of excess income
These must be made both regularly (or, if just once before death, made with the intention of being the first of many) and out of surplus income, leaving sufficient income for the deceased to maintain their usual standard of living.
Gifts which are always exempt
A person can make gifts to certain people and organisations without having to pay any IHT and these gifts are exempt whether made during life or on death:
- husband, wife or civil partner, as long as they have a permanent home in the UK
- a ‘qualifying’ charity established in the EU or another specified country
- some national institutions such as Museums, Universities and the National Trust
- any UK political party that has at least two members elected to the House of Commons or has one elected member, but the party received at least 150,000 votes