INHERITANCE TAX - PLANNING - 25.03.2009

Annual reliefs from tax

When does Inheritance Tax hit?

Inheritance Tax (IHT) is payable on the value of your estate when you die. The Taxman will assume anything you have given away within seven years of death is part of this estate. However, this excludes some gifts that are fully exempt, see below. If, after any deductions, your estate is worth more than the “nil rate band”, currently £312,000, IHT will be charged. So here’s what you can do to keep the IHT bill to a minimum.

Annual exemption

You may give £3,000 of cash or other assets away every year without any IHT consequences at all. If you didn’t do this last year, then you can add this exemption to this year’s, meaning that you could give away up to £6,000 by April 5 2009.

Tip. The annual exemption applies to all individuals. Sospouses or civil partners each have an annual exemption. (This rule also applies to the other exemptions mentioned below.) So, for example, if you want to make a gift of £6,000, it’s more tax effective for each spouse to give away £3,000.

Gifts

Small gifts. You can make gifts of up to £250 to anyone you like. These are fully exempt from IHT. But curiously enough, if you give £251 to anybody, the whole £251 will be taxable and not just the odd £1!

Gifts on marriage. A gift by a parent to their child who is getting married is exempt up to £5,000. But if you are the grandparent or great-grandparent, the limit is £2,500. For aunts and uncles, the limit is £1,000.

Normal expenditure out of income

All gifts out of income are fully exempt from IHT as long as they are part of your “normal expenditure”. To qualify as normal expenditure the gift must be regular, essentially every year, but there can be exceptions (see The next step). So, for example, if you have income of £65,000 a year and you only spend £55,000, you could give the difference of £10,000 away as normal expenditure without IHT consequences.

What’s the right asset to give?

Apart from the case of the normal expenditure exemption, gifts do not have to be in the form of money. So shares or other investments will be fine. When deciding on what to give away, think about future potential. Aim to give away assets that may for some reason currently have a low value but have potential for improvement.

Tip. If you’re thinking of making gifts and you own shares, these may be a good choice. Due to the current financial crisis, values may be low. If you give shares away now, and the market recovers, any increase in value will be outside of your estate.

Trap. To work for IHT planning you must not receive any benefit from the asset you give away. The Taxman calls this a “gift with reservation” and it will be treated as part of your estate for IHT purposes. For example, if you give your house to your children and carry on living in it without paying full market rent, that would be a gift with reservation. And would still be counted as part of your estate.

For more information on the normal expenditure exemption, visit http://companydirector.indicator.co.uk (CD 10.12.07).