Using gifts, reliefs and exemptions to reduce your Inheritance Tax

Reducing Inheritance Tax (IHT) is a common request from many people. However most fail to realise the best time to share their wealth is years before they've even considered estate planning. Learn the basics behind using gifts, reliefs, and certain exemptions to Inheritance Tax to improve your estate planning today. 

Can gifts reduce Inheritance Tax in the UK?

You may have heard that making gifts in your lifetime can help reduce the IHT due on your death. This is broadly true for gifts to individuals, but there are several criteria to take into consideration:

1. The gift has to be more than 7 years before your death,

2. You cannot derive any direct or indirect benefit from the asset once it has been gifted, and

3. There could be a Capital Gains Tax charge (plus other taxes) to consider at the time of the gift.

What other IHT reliefs or exemptions can I claim?

You’ll pay no IHT on assets left to registered charities or your spouse (whether married or in a civil partnership).

Every individual’s estate is entitled to a tax-free threshold known as the Nil Rate Band, currently £325,000 (although this can be reduced by gifts in lifetime).

If your estate includes your home (or the proceeds of your home), you could receive an extra tax-free threshold of up to £175,000. The threshold is capped by the value of your property.

If either of the tax-free thresholds above are not used in full on your death, these transfer to your spouse who survives you.

How does HMRC know if you have gifted money?

If you’re asking how to conceal gifts from HMRC, this is never an option.

HMRC’s systems are sophisticated, and they can access information held by numerous institutions. Taking this into account, HMRC will be able to track payments/withdrawals or cross-examine details about legal ownership.

Instead, people should seek clear advice tailored to their individual needs and feel reassured that their tax planning aligns with their wishes and HMRC's requirements.  

Are there strategies for reducing Inheritance Tax on family property?

A good starting point is to look at your current exposure to IHT, and then establish if there are any reliefs you could better utilise.

Are your loved ones “ready” to have the responsibility of your assets (this is a question for you, not them)?

Are there any assets that you don’t need to maintain your standard of living in your lifetime? This is not a one-off exercise but something that should be frequently reviewed as your needs and priorities change.

What is your attitude towards Inheritance Tax? Are you happy to pay:

• Any sum of IHT, no matter the cost?
• Maybe a little bit of IHT?
• Absolutely nothing?

These are typically the areas a professional tax adviser will discuss with you to create an estate plan that meets your requirements. 

Do businesses enjoy any relief from IHT? 

Do you hold an interest in a business that is actively trading? You may receive 100% Inheritance Tax relief (known as 'Business Property Relief') on the first £2.5 million. The value in excess of this would receive 50% IHT relief – the effective Inheritance Tax rate is therefore 20%.

Are there any IHT reliefs or exemptions for farmers or farm-owners?

 If you own farmland that is actively farmed by yourself or a tenant, you may receive 100% IHT relief (known as “Agricultural Property Relief”) on the first £2.5m of the agricultural value of the land with the value in excess of this only attracting 50% Inheritance Tax relief. It is important to note that it is only the agricultural value which obtains relief, not any hope or development value attached to the farmland.

The total business property relief and agricultural property relief that can be obtained at 100% is £2.5m. These reliefs are an area where you will need specialist tax advice.

Niche IHT reliefs for farmers

There are some other more “niche” IHT reliefs available, such as if you own woodlands or items that qualify as national heritage assets. Again, specialist tax advice should be sought in respect of these.

How does IHT work with investments?

Alongside the aforementioned reliefs on agricultural and business property assets, some investments will qualify for certain reliefs. If you own shares in the Alternative Investment Market (AIM) market, you can receive 50% IHT relief on the value of the shares.

What if I pass away while owing outstanding debts?

Should you die whilst owing money to anyone, the value of these liabilities will be deductible from your estate. Typically, if the liability is secured on an asset (like a mortgage on a property), the debt will be offset against the asset. However, there are some instances when this is not the case. We recommend you first check with your tax adviser.

How to manage your inheritance tax bill

The best way to manage your Inheritance Tax bill is to have no IHT to pay on death.

Is this possible? Yes.

Is it realistic? Not always, especially if you want to maintain a certain lifestyle or if you starting implementing tax advice early enough.

Sometimes, Inheritance Tax planning is determining how much you are willing to give away against what you want to keep until you pass on. It's realising what you're willing to pay IHT on.

Once you have worked this out, what can you do to manage your Inheritance Tax?

1. Take financial advice from a qualified individual to determine whether a life insurance policy is appropriate for you and could be used to pay for Inheritance Tax costs on your death.

2. Ensure you have liquid assets to help your executors easily pay IHT.

3.  IHT on certain assets can be paid by annual instalments over ten years (this may be interest bearing) and your executors can elect for this approach. 

4. Your executors could also take out a loan to pay the Inheritance Tax while assets are being sold to raise the funds.

5. Your executors may also want to take tax advice to understand if there is any way to mitigate IHT due on the estate.

What taxes do my heirs have to pay on their inheritance?

If there is a silver lining to IHT, it is that your heirs shouldn’t have to pay any additional taxes to receive the assets left to them. However, your heirs do need to be aware that:

• If the assets have increased in value since the date of death, Capital Gains Tax will be suffered on the disposal of the asset.
• Income (e.g. dividend, interest, etc.) attributable to the asset can be assessable on them personally.
• As a result of receiving an asset, they too may have just increased their exposure to IHT and so they should seek their own tax advice.

Enjoy peace-of-mind with tax planning

If you're ready to be more efficient in your tax planning, Shorts can help. Estate planning can require complex structures and timelines to be as tax-efficient as possible, often requiring specialist support. Our Private Client team has extensive experience supporting clients with intricate estate plans and goals. 

For those wanting to learn more about gifting and Inheritance Tax, our latest episode of Accountable by Shorts dives into the pitfalls and benefits.