Most forms of tax relief or exemption have an upper limit, such as the income tax personal allowance.
However, Gifts out of income have no upper monetary limit and are exempt from IHT subject to certain conditions.
What are “Gifts Out of Income” and how can they be used to lessen IHT?
The normal expenditure out of income exemption applies to certain gifts, such as cash and, in some instances, chattels. The exemption is limited only to the extent of a testator’s surplus income. It can be a very useful way to reduce the size of your estate, and therefore lessen the amount of IHT paid by your loved ones.
There are qualifying conditions to be met. Amongst other things the gift must be made as part of the normal expenditure of the benefactor; the benefactor must retain sufficient income to maintain their standard of living; and gifts must be made from income.
It is surprising that more people do not make use of it.
The gift must be made as part of the normal expenditure of the testator
HMRC’s interpretation is that gifts should form part of a regular pattern of payments. An exemption may be made available where there is evidence that the testator had made a commitment regarding any future expenditure. This needs to be documented so as to avoid problems for your personal representatives later.
The testator must retain sufficient income to maintain their standard of living
The amount of the surplus obviously varies all the time It is helpful to prepare an income and expenditure assessment, each year, to clarify the position. Any document that provides evidence of a gift, should also confirm that despite the gift (and any similar gifts made) the testator will have sufficient income to maintain their usual standard of living.
Gifts must be made out of income
The exemption can only apply when expenditure is from surplus net taxable income. This can include salary, dividends, pension or business profits. Income can be identified in the same year as gifts have been made, as it demonstrates that there is sufficient income available.
However, income from earlier years is not seen as income indefinitely. There are no set rules about when accumulated income becomes capital. HMRC will normally consider this to be after two years. This can cause a problem where income has been accumulated.
A recommendation is that the testator writes a letter to their chosen beneficiary to record the gift. The result of this means that keeping a copy of the letter represents evidence of the testators’ intentions. Furthermore, financial records of gifts, such as bank statements, can help demonstrate that payments have been made. Additionally, documentary evidence that shows that such payments are gifts can be helpful, this can be a simple, signed ‘Gift Memorandum’ or even a letter to the intended recipient.
However, always talk us before making any sizeable gift. There are potential problems that you need to be aware of, such as the possibility of the recipient’s relationship breaking down. This can lead to a substantial amount of your gift leaving the family, and disappearing with your ex in-law! We are able to offer solutions for this.
If you would like to know more about inheritance tax and the various tax-saving schemes, please do not hesitate to contact Christopher Seddon, who is the head of our Private Client Team, or Sophie Barton, one of our Private Client Solicitors, for guidance and an initial free telephone consultation.