Stand-out Q – TYE #2…
Our Technical Hub provides access to a wide range of pension tax and trust technical resources. Every now and then we post tweets covering stand out questions from our technical content and our answers in case others might also find them helpful. As Twitter’s character restrictions only allow for the bare bones of the Q&A we link to the details here, too.
Client made gift to discretionary trust to use their nil rate band last tax year. Can they make more gifts without worrying about IHT?
Individuals have a lifetime annual exemption (LAE) of £3,000. This can be carried forward for one year but will then be lost if unused. The current year’s exemption is used first.
Marlon makes a gift of £5,000 to a discretionary trust on 6 March 2018. He makes no other gifts in the tax year.
The 2017/18 LAE is offset against the gift in full and the remainder of the gift is covered by £2,000 of the 2016/17 LAE. On 6 April 2018, the £1,000 unused LAE from 2016/17 is lost.
The LAE is set off in a strict chronological order. It is therefore generally advised that any chargeable lifetime transfers (CLTs) (gifts to discretionary trusts) are made before any potentially exempt transfers (PETs) (to other individuals).
This is because a CLT attracts an immediate IHT charge at the lifetime rate of 20% once the donor’s nil rate band has been exceeded and any other exemptions exhausted, whereas a PET is treated as exempt (so incurs no IHT charge) when made. A PET will only become chargeable if an individual dies within 7 years of the gift. Any LAE can therefore be wasted on the PET if the gift to the PET is made first.
Al made a £331,000 gift to a discretionary trust in 2016/17 which used up his LAEs for 2015/16 and 2016/17 and his available nil rate band. He makes a further gift of £9,000 to the trust on 7 March 2018. He makes a gift of £7,000 to his daughter Diane, on 8 March 2018.
The gift on 7 March 2018 uses the LAE for 2017/18, reducing the chargeable element to £6,000, which will be taxed at 20%. The LAE for 2016 was used up in 2016/17 when Al gifted £331,000 to the trust.
The gift to Diane is a PET, so no IHT charge is due unless Al dies within 7 years of the date of the gift.
If the £9,000 gift had not been made to the trust until 9 March 2016, the full £9,000 would have suffered IHT at 20% as the LAE would have been used against the gift to Diane on 8 March, even though this gift is a PET and does not attract an immediate IHT charge.
The LAE can be important for clients who have invested in discounted gift trusts or loan trusts. They can use the LAE to waive their entitlement under the discounted gift trust or reduce the outstanding loans under a loan trust. Using the LAE in this way increases the value within the trust and can also reduce the value of the donor’s estate which will be liable to IHT.
There are a couple of other exemptions in the IHT legislation which can be useful when making gifts to another individual. Even if the donor dies within seven years, when PETs normally become chargeable, where these exemptions apply the gifts will continue to be exempt.
The first type of gift is the gift in contemplation of a marriage or civil partnership. The legislation states that the gift must be made to one party to the marriage and must be made in respect of any one marriage or civil partnership. It is not therefore possible to make the gift on the expectation that, for example, a granddaughter could get married at some point in the future.
The amounts which can be gifted and which will be covered by the exemption depend upon the relationship between the person making the gift and the recipient The following table summarises the amounts which the named relatives can make to take advantage of the exemption:-
There is also a small gifts exemption for gifts totalling under £250 in any tax year. This is an “all or nothing” exemption.
So long as the total gifts to the same recipient in the same tax year are under £250, the whole gift is exempt from IHT. If the sum exceeds £250, the exemption is not available, although most gifts, if they exceed £250 over the year, e.g. Christmas and birthday presents, will be PETs.
The £250 can be used on an unlimited number of recipients in any tax year.
James gifts £3,000 each year to a family trust to use his LAE every 6 April. He has 10 grandchildren. He receives a generous pension and can afford to give each grandchild £150 for Christmas and a further £100 as a birthday gift from his savings.
No gift exceeds £250 to any recipient, so all gifts are within the small gifts exemption.
The following year, his eleventh grandchild, Talia, is born. He continues to make £150 to each grandchild as a Christmas present and £100 as a birthday present. Gifts to all 11 recipients are within the exemption.
If, however, he made an extra gift of £500 to Talia to commemorate her christening, the gifts to Talia in the tax year would total £750 and so not be covered by the exemption. However, they would be PETs and so only chargeable if James does not survive 7 years from the date of each gift.
Follow us on Twitter – @JHPartnership