Lifetime gifts: estate planning and the 14 year IHT rule
Gifts made within 14 years of death can still attract IHT. But how does this rule
operate in practice? Nicola Neal explains.
Making lifetime gifts for inheritance tax (IHT) purposes is currently a hot topic. The lifetime gift of £200,000 from Mary Cameron to her son, David, has prompted fairly extensive media coverage of the rules regarding lifetime gifts for IHT purposes.
For those who are likely to be exposed to IHT on death, lifetime gifting is a firmly established, highly-effective and legitimate means of mitigating IHT.
However, while many will be familiar with the ‘seven year survival rule’, fewer are aware that, in certain circumstances, gifts made within 14 years of death can still attract IHT. But how does this rule operate in practice?
Generally, there are three types of gifts for IHT purposes:
Exempt transfer (ET)
An ET is a gift that qualifies for a specific exemption from IHT, such as gifts to spouses, civil partners or charities.
Potentially exempt transfer (PET)
Broadly, a PET is a gift of property to an individual (other than to an exempt beneficiary). Provided the donor survives seven years from the date of the gift, and retains no benefit in the gifted asset, the value of the gift will fall out of the donor’s estate for IHT purposes on death.
Should the donor die within seven years, the value of the gift (now a ‘failed PET’) will be aggregated with the deceased’s estate, and IHT may be chargeable if the total of the failed PET and the deceased’s assets at the time of their death exceed the IHT nil-rate band (NRB), which is currently £325,000. However, in certain circumstances, taper relief may apply to reduce the IHT payable where the donor survived for at least three years following the PET.
Chargeable lifetime transfer (CLT)
The third type of gift is a CLT. The most commonly encountered type of CLT for private client practitioners is the transfer of assets to a trust (other than a gift made to a specific type of trust, such as a transfer to a disabled trust, which may still constitute a PET).
If the combined value of the ‘current’ CLT and any CLTs made within the previous seven years of the current CLT exceeds the NRB, then this will create an immediate IHT liability at the lifetime rate of 20% on the excess value above the NRB. There will be no further IHT to pay, unless the person making the CLT dies within seven years. Even if further IHT is payable as a result of death within seven years, taper relief may also apply to reduce the liability.
The 14-year rule
So far, so straightforward. However, matters become a little more complicated if the deceased made the first gift (a CLT, not a PET) more than seven years before their death, followed by a second gift (a PET) made within seven years of the first gift. Here, the earlier CLT may also be caught by the IHT regime, inviting the possibility of IHT being paid on gifts made up to 14 years pre-death. As an example:
- year one: Charles made a CLT to a trust of £50,000
- year six: Charles made a PET of £300,000 to his daughter
- year 10: Charles dies
At first glance, you may assume that the CLT, having occurred more than seven years pre-death, can be ignored, and no IHT will arise on the now failed PET, as it is fully covered by the NRB.
However, this is not the case, as to calculate the available nil-rate band available to offset against the PET, it is necessary to consider events that occurred in the seven years preceding the PET.
So, in the above example, though there is no IHT on the CLT, it nevertheless reduces the NRB to £275,000. When calculating the IHT position of the failed PET, the position is as follows:
- value of PET: £300,000
- less NRB: (£275,000)
- IHT @ 40% of £25,000: £10,000
To summarise, a CLT made within 14 years of death may not itself create an IHT liability on death. However, it could nevertheless reduce the NRB available to offset against a subsequent PET where death occurs within seven years of that PET and 14 years of the initial CLT.
In this sense, for those considering making a PET and a CLT at or around the same time, it is advisable for the donor to make the PET before the CLT. However, when making a PET, the donor should also be wary of any CLTs made in the previous seven years, and may want to consider postponing the PET until the expiry of the seven-year period from the initial CLT.
About the author
Nicola Neal is a senior solicitor at Brodies LLP, follow @BrodiesLLP.
Publication date: 4 May 2016