How the 7 years rule applies to Inheritance Tax
You shouldn’t be afraid of giving your loved ones gifts, you don’t immediately incur inheritance tax when you make a gift whilst you’re alive. However you should look into the tax liability on your estate after your death if you are going to give away a lot of money in one go. The amount of tax to pay on a gift depends on whether it was given within 7 years before death.
Everyone has an ‘annual exemption’ of £3000 a year to give to a single recipient before it incurs inheritance tax. These gifts are known as ‘potentially exempt transfer’ or PETs. They are potentially exempt as you won’t pay tax on them if you live for another 7 years after the gift is given.
However if you were to pass away within 7 years of the gift being given the full amount of the gift will be counted as part of your estate. If the amount of the gifts given within 7 years takes your estate over your personal threshold which is currently at £325,000 then your estate will be liable to pay inheritance tax. You only pay inheritance tax on the amount that is over the £325,000 threshold. For example if the total value of the estate is £350,000 you will be eligible to pay 40% on the £25,000 which is above the threshold so you would pay £10,000 in inheritance tax.
Depending on when the gift was given it may not be taxed at 40%. The amount of tax payable is reduced according to the amount of time between the gift being given and the date of death. This is known as ‘taper relief’. Gifts given more than 7 years before death are not counted as part of the estate.
Years between gift and death Tax paid
Less than 3 years 40%
3 to 4 years 32%
4 to 5 years 24%
5-6 years 16%
6-7 years 8%
7 or more years 0%
Regardless of when the gift was given the full amount will always be counted as part of the estate. The ‘Tapering’ refers to the amount of tax payable on the gift that is over the inheritance tax threshold. For example if a gift of £25,000 was given 5 years before death, the £25,000 will count towards the estate but would be taxed at 16%.
The Tapered relief does not apply to the estate that is under your inheritance allowance threshold of £325,000. The relief is used against the inheritance tax that is owed once the estate has been fully assessed.
You can carry 1 years’ worth of allowance onto the next year but only for one year. This means you can’t use several years’ worth of allowance on one gift.
It is important to keep a record of any high value gifts you have given.
It is advised that you seek professional advice if you are going to be making large gifts, so that you can fully understand the tax liabilities on your estate. If you are an executor of an estate and believe you may be eligible to pay inheritance tax on an estate give a member of our team a call on 08007318722 who can provide you with a fixed fee probate quote for a fully qualified solicitor to administer the estate on your behalf.