Out of all the tax reliefs and exemptions, probably the most generous of them all is the Inheritance Tax (IHT) exemption for 'normal expenditure out of income'. This is because it has very few limitations ...
What limitations it does have are very broad, made up of your individual circumstances, and the amount of surplus income you could give away. To satisfy the conditions:
- The gift was part of your own normal expenditure
- It was made out of your own income
- You had money left over to maintain your usual standard of living
So, good so far! That all seems to be pretty straightforward, yet in practice, everyone's circumstances vary wildly, so it can often be difficult to determine whether the exemption can be applied.
However, with the right tax advice, you can be sure that all the conditions are met and the 'normal expenditure out of income' exemption can apply, sheltering significant gifts as far as IHT is concerned.
Normally, a gift, say between a father and daughter, is a Potentially Exempt Transfer (PET) as far as Inheritance Tax is concerned, only becoming exempt if the donor survives for seven years.
By contrast, if the exemption circumstances are met, the seven-year waiting period does not apply, but expect HMRC to seek to clarify if the exemption was satisfied if the donor dies within seven years.
Let me give you an example:
Doris is 85 and her net income after tax is £54,000 per year. This is made up of both pensions and investment income. She lives modestly and has been able to save £2,500 per month for some time.
She makes regular gifts of £1,500 per month, split between her two adult grandchildren. As long as HMRC accepts these regular gifts met the exemption criteria, she could still make use of her annual IHT exemption in respect of other gifts.
HMRC will look for patterns over a number of years to establish if the gifts are eligible or not. It is possible to shorten that period providing you have sufficient documentation to prove it. Regular gifts are more likely to meet the criteria than one-offs.
Be careful here. If you gift more than your income in a year, HMRC would see that as capital because you would not be left with sufficient income to maintain your usual standard of living.
As always, good record keeping on your part keeps HMRC happy.
If you'd like to find out more about anything I've written here, do call me on 01908 774323 or leave a comment below and let's see how I can help you.