WARNING – 14 Year Inheritance Tax Trap
Can gifts still be subject to Inheritance Tax 14 years later?
Many will be familiar with the seven-year rule relating to gifts for inheritance tax (IHT) purposes. And, assuming you survive for seven years from the date of making the gift, this gift can be excluded from your estate after you die. However, there is also a 14-year rule that can, in certain circumstances, attract IHT.
How IHT and gifts work
So, let’s start by looking at the three main types of gift from an IHT perspective:
- Potentially Exempt Transfer (PET) – This is used for a gift of property to an individual. Provided the donor retains no benefit from the gift, this is not subject to IHT at the time of the transfer or if the donor survives seven years. However, the gift is liable for inclusion in IHT calculations if the donor dies within seven years of making the transfer.
- Chargeable Lifetime Transfer (CLT) – This is one of the most commonly used gifts. Assets that are immediately chargeable to IHT are transferred into a trust. If the value of the CLT(s) (this can be more than one and will include current and past), exceeds the IHT threshold, then any tax due would be charged at a maximum of the lifetime rate of 20% when the value is transferred. Should the donor die within seven years, additional IHT may be due.
- Exempt Transfer – These are gifts that qualifies for immediate exemption and are not subject to the seven-year PET rule or ‘entry charge’ of 20% as with CLTs. These typically include gifts to spouses or civil partners and charitable donations.
CLT’s are usually considered first
If you don’t have any PETs or CLTs in place, it’s usually best to make a CLT first. If you choose this option, then you must be careful to avoid an immediate charge if it takes you over the nil-rate band (NRB).
The inheritance tax threshold or nil-rate band (NRB) is the threshold above which a person’s estate must pay Inheritance Tax. It’s currently set at £325,000 and will stay at this level until April 2021. Thereafter, it will increase in line with the Consumer Prices Index.
But, when calculating what NRB is available on death and whether additional tax is due on previous ‘gifts’, it may be necessary to go back 14 years not seven years.
How the 14-year rule can affect you
Whilst most gifts you make within your lifetime are either exempt transfers or PETs, in that there are no strings attached to the gift and no inheritance tax is due.
However, where trusts or CLT’s have been set up well within the seven-year period, followed by a second gift such as a PET, and you die within the seven-year period, your estate may attract a higher rate of tax.
Example One – June’s Estate
No previous gifts
June died 1 February 2018, she has an estate of £625,000 and has made no previous gifts other than using annual exemptions.
£625,000 – £325,000 NRB = £300,000 x 40% = £120,000 tax
Example Two – Tom’s Estate
Tom also died on 1 February 2018. He also has an estate of £625,000 but made two previous gifts. A CLT of £150,000 on 3 February 2004 and a PET of £215,000 on 2 February 2011.
The PET fails as seven years has not elapsed. To calculate additional IHT tax to pay on the failed gift we need to consider any other failed PETs or CLTs. As the CLT was made within seven years of the failed PET, the CLT of £150,000 would be added to the failed PET of £215,000 to see if additional tax was due.
Tax due on the PET:
£150,000 + £215,000 – £325,000 (NRB at death) = £40,000.
£40,000 x 40% = £16,000.
As the failed PET was made between six and seven years prior to death, taper relief would be available reducing the tax due:
£16,000 x 20% = £3,200.
This would be paid by the recipient of the PET.
PETs made more than 7 years before death would be exempt so would not be added into any calculation.
Tax due on Tom’s estate:
The estate’s NRB will be reduced by the failed PET.
NRB £325,000 – £215,000 = £110,000.
£625,000 – £110,000 = £515,000.
£515,000 x 40% = £206,000.
The estate’s NRB will not be reduced by the CLT because it was made more than seven years prior to death.
If the PET had been on 4 and not 2 February 2011 i.e. more than 7 years since the CLT on 3 February 2006, it would still fail, but the CLT would be outside the accumulation period. There would have been no additional tax on the PET, saving £3,200.
It’s clear from our examples that gifts made up to 14 years before death can attract tax, However, if you are considering making gifts over an extended period, it’s very important to understand the implications of unexpected tax on the gifts as well as a reduction of available NRB, should death occur within 7 years.
As you can see, the rules are complex and where you set up a trust, it’s important to speak to your lawyers and financial adviser or accountant to help you mitigate an unexpected tax burden.
For more information or advice about planning for the future, please contact us, we’re here to help.
Please note that all views, comments or opinions expressed are for information only and do not constitute and should not be interpreted as being comprehensive or as giving legal advice. No one should seek to rely or act upon, or refrain from acting upon, the views, comments or opinions expressed herein without first obtaining specialist, professional or independent advice. While every effort has been made to ensure accuracy, Curtis Parkinson cannot be held liable for any errors, omissions or inaccuracies.