INHERITANCE TAX - 22.06.2018

Make clients aware of the taper relief trap

PET Problems

When your clients make gifts that aren’t exempt during their lifetime, it will usually be a potentially exempt transfer (PET). This means that the well-known seven-year rule is invoked, meaning that if the donor survives until at least the seventh anniversary of making the gift, it falls outside the estate for inheritance tax (IHT) purposes.

Many of your clients will have a rudimentary understanding of this, and possibly even of the taper relief provisions that can help alleviate the tax charge where the donor dies within seven years, i.e. the PET fails.

Taper relief

Taper relief works by reducing the IHT payable in respect of a failed PET where the donor dies before seven years have passed, but at least three have elapsed. This can offer some reassurance for families making lifetime gifts. The reduction applies by reducing the amount of tax payable by a factor of 20% for each anniversary after the third.

Pro advice. Ensure your clients are aware that it is the tax that is reduced, not the value of the PET itself. This is a very important distinction.

Misconception

Unfortunately, taper relief may be less valuable than your clients think. This is down to the order in which the IHT legislation taxes the estate. Failed PETs are brought into charge first, in chronological order. The problem is that if the PET is covered by the nil rate band (NRB), which is £325,000 for 2018/19, then taper relief won’t save your client any IHT. As mentioned above, taper relief reduces the tax payable, not the value of the gift, so if the tax due is £nil no relief is available.

Example. Your client John has been looking at his wealth, and has estimated his entire estate to be worth £750,000. He has gifted his son £100,000 to reduce this to the level of his NRB, plus the unused NRB he can transfer from his deceased spouse, as this should mean no IHT is payable. John believes that if he survives three years, the potential IHT charge will reduce by £8,000 each year.

Unfortunately, John is incorrect. The PET will attract taper relief. However, it will apply to £nil as the £100,000 will fall within the available NRB so there will be no reduction in IHT. Instead what will happen is the remaining estate of £650,000 will only have £550,000 of available NRB to offset. The executors will therefore potentially face a £40,000 IHT bill they didn’t expect.

Planning and fixing

If your client is in this situation and wants to secure some reduction in the amount payable, they could consider a term insurance policy to cover the seven years. The payment would be for an amount to cover the potential IHT.

Pro advice. If your client has already made a gift like in the example above, they should set up the policy to run until the seventh anniversary of the gift.

An alternative would be to use a discounted gift product, which can reduce the value of the gift immediately. We looked at how such products work in yr.2, iss.7, pg.5 , (see Follow up ).

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