You may feel compelled to support family members financially for a variety of reasons, but one of the aspects that is often not considered is the impact it can have on Inheritance Tax (IHT).
There are specific conditions that must be met for gifts to be made without them being chargeable for IHT purposes, so understanding how the normal expenditure out of income exemption under Section 21 of the Inheritance Tax Act 1984 works is vital for estate planning.
What is meant by gifting out of income?
If a gift could reasonably be considered part of your regular spending habits and is paid from your income without diminishing your quality of life, then it may be exempt from IHT under Section 21.
Gifts given from capital or savings are not affected by this exemption as it strictly applies to gifts made from surplus income.
This means that taking a withdrawal from an investment bond or using the capital part of a purchased life annuity payment may still be subject to IHT if it is given as a gift.
You cannot use these other funds to top up your income either, as the gift has to be from surplus income, meaning that your remaining income has to cover all of your normal living costs without any shortfall.
Should you achieve this, the gift that is given would likely be viewed as a gift out of income for IHT purposes.
Maintaining clear records is key for gifting out of income
As the exemption is likely to be claimed after you have died, you will not be present to advise your family or HMRC on how the gift or your funds were handled.
This means that you need to establish a repository of evidence while you are alive that demonstrates your awareness of and compliance with Section 21.
At the core of this will be HMRC form IHT403, as this allows you to record gifts as soon as they are made so that they can be accurately reflected in future claims.
Gifting rules typically apply to gifts given up to seven years before a person dies, so your records must extend to the previous seven years just in case your evidence is required sooner than anticipated.
You should add together any chargeable lifetime transfers and any gifts made under exemption to determine whether the value is higher than the current Nil-Rate Band (NRB).
If you cross the NRB, you must report all gifts using form IHT 100.
HMRC will then review the form to determine the application of the exemption and issue a confirmation of its decision in writing.
Should the value of your gifts remain below the NRB, you will need to ensure that it can be evidenced when the exemption is reviewed after your death.
Executors will use forms IHT 100 and IHT 403, so it is worth making sure that they have easy access to all of the information they will need.
Our expert team is on hand to help you plan for the future in the face of rising IHT exposure.
We know how important it is to secure your financial legacy, which is why we will work with you to determine the estate plan that matches your unique situation.
For full support with Inheritance Tax planning, get in touch with our team.
