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Technical View

All gifts where the donor dies within seven years benefit from IHT taper relief; don’t they?

This question, or variations thereof, is one we are frequently asked and to which we reply ‘not necessarily’. As we like to be as helpful as possible we do then expand on what we mean by ‘not necessarily’, rather than leave it hanging there.

The important thing to remember about IHT taper relief is that it reduces the amount of IHT due on a failed gift but it does not reduce the value of the failed gift itself. Where a gift fails due to the donor passing away within seven years taper relief will only come into play if the deceased has survived the gift by three years and IHT is due on the failed gift in the first place.

Setting out when IHT taper relief will and will not apply is best explained by way of examples, although before doing so it is worth noting the rates at which the relief is applied.  

Years between gift and death Rate of relief
0 - 3 0%
3 - 4 20%
4 – 5 40%
5 – 6 60%
6 – 7 80%

 

Example 1 – no taper relief available


Marc made a lifetime gift of £256,000 to his son David. The gift, which is the first Marc has made, is a potentially exempt transfer (PET) and no tax was payable on making the gift. Five years later Marc passes away leaving an estate of £500,000 to his son. Marc was a widower and his deceased wife’s nil rate band (NRB) was fully used on her death.

As Marc died within seven years the gift is a failed PET and forms part of this estate for IHT purposes, the PET is taken into account first before considering IHT on the remaining estate.

The IHT position in respect of the PET will be:

  • Value of the PET £250,000 (£256,000 – 2 x £3,000 annual gift exemption)
  • Available NRB £325,000
  • No IHT is payable on the PET as it does not exceed the available NRB.
  • NRB to set against the death estate £325,000 - £250,000 = £75,000 

While the IHT payable on the death estate is:

  • Value of estate on death £500,000
  • Less remaining NRB £75,000
  • IHT payable £425,000 x 40% = £170,000
  • Leaving David with £330,000. 

Example 2 – when taper relief will apply


Ron made a lifetime gift of £400,000 (PET) to his son Russell, having made a smaller gift of £6,000 to his niece the previous week to celebrate her graduation utilising his available annual gift exemption. No tax was payable when either gift was made.  Four years later Ron passes away leaving his estate of £600,000 to Russell, his wife having pre-deceased him and her NRB was fully used. 

Again death occurred within seven years of the gift so the failed PET forms part of the estate for IHT.

The IHT position in respect of the PET will be:

  • Value of the PET £400,000
  • Available NRB £325,000

  • PET exceeds NRB so IHT payable on excess

  • IHT on £400,000 - £325,000 x 40% = £30,000

  • Ron survived the PET by four years so taper relief at 40% will reduce IHT liability

  • Taper relief £30,000 x 40% = £12,000

  • IHT due £30,000 - £12,000 = £18,000

  • No NRB left to set against the death estate

IHT payable on the death estate is:

  • Value of estate on death £600,000

  • Available NRB £0

  • IHT payable £600,000 x 40% = £240,000

  • Leaving Russell with £360,000

While the above examples are relatively simplistic they should serve to illustrate the principles. In a more complex situation involving multiple failed PETs and/or chargeable lifetime transfers (CLT) the same principles will apply. Each failed PET or CLT is looked at in chronological order, starting with the earliest, to determine the NRB available to each and where applicable any taper relief. 

Is there anything Marc and Ron can do to help alleviate the IHT burden and allow more of their respective estate to pass to their sons?


Aside from the obvious answer of surviving any lifetime gift by seven years there are other steps that can be taken.

The loss of or reduction in NRB could be covered by a seven year level term assurance policy written on the life of the donor in trust for the beneficiaries of the estate. The sum assured should reflect the additional IHT liability arising due to the loss of or reduction in the NRB.

A ‘gift inter vivos’ term assurance policy is designed to cover the IHT liability on a failed gift, once again it is written on the life of the donor. The sum assured will be in line with the potential IHT liability reducing accordingly as taper relief begins to kick in. The policy should be written in trust for the recipient(s) of the gift. 

The feasibility of the life cover route will be largely dependent on the life assured’s state of health and age which in turn will affect the affordability of life assurance.

Summary


So to round off the key point to take away is that taper relief will only apply where a failed gift leads to an IHT liability on the donor’s death.

We like to use ‘No TNT’ as memory jogger to explode the myth of IHT taper relief – No Tax No Tapering.  

This note is to be used by Financial Advisers only. It is not intended for onward transmission to a private customer and should not be relied upon by any other person. Sanlam accepts no liability for any action taken or not taken by an individual or firm as a result of the contents of this material. The tax treatments and information contained in this document is based on current tax law and HMRC practice as at October 2016 and may be subject to change in the future. Whilst we have made every effort to ensure the accuracy of this material, we cannot accept responsibility for any consequence (financial or otherwise) arising from relying on it. This document is for information purposes only and should not be treated as advice and independent taxation advice should be always sought.
 
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