How Does the 7 Year Inheritance Tax Rule Work?
This blog explains some of the complicated rules around Inheritance Tax, including Taper Relief and the seven-year rule. It’s very important that you understand these rules and how they work because if you get them wrong, it could cost you a lot of money.
The Seven Year Rule
This rule only applies to gifts that are made in excess of £3000. If the gifts that you make exceed £3000 in any given year, then it will become a Potentially Exempt Transfer (PET) or a Chargeable Lifetime Transfer (CLT). PETs apply to direct gifts to people that exceed £3000 whereas CLTs are gifts into Trusts.
Potentially Exempt Transfers
PETs have no limit. If you wanted to give away £10 million, you could, and if you live for seven years after this, then this will fall outside of your estate. However, you need to be careful. If you gift large amounts to your children directly and they go bankrupt or get divorced, you would have no control over the gifted money, and as a result, it could leave the family bloodline.
Chargeable Lifetime Transfers.
CLTs are gifts into Trust, and they too have no limit. Yet, if you gift more than the Nil Rate Band (currently £325,000) then the excess will be charged at 20% immediately.
If you make a gift into a PET, then Taper Relief might apply. Taper Relief is a tax reducer. It doesn’t reduce the amount of capital transfer for Inheritance Tax, it reduces the tax payable. It is important to know that Taper Relief only applies to the excess of gifts which exceed over £325,000. For example, if you gift £525,000, then Taper Relief would only apply to the excess £200,000.
The below ‘Taper Relief: Sliding Scales’ is a handy diagram showing the differing tax rates that apply. For example, the diagram illustrates how Taper Relief only starts after three years. You can use the diagram to see how the amount of excess that you’re gifting corresponds to the Taper Relief rules.
|TAPER RELIEF : SLIDING SCALES|
|Time between date of |
gift and date of donor’s
|Taper relief applied to tax due||Effective rate on gift|
|0 to 3 Years||0%||40%|
|3 to 4 Years||20%||32%|
|4 to 5 Years||40%||24%|
|5 to 6 Years||60%||16%|
|6 to 7 Years||80%||8%|
The Seven Year Rule and Fourteen Year Rule in More Detail
Let’s say that you make a PET in year one and you lived over seven years. Here, the money would be out of your estate after the seven years, and you would pay no tax. Now imagine you make another gift in year six and you lived for over seven years after that. Even though the two gifts overlap, there would be no issue as each PET is accounted for individually for tax purposes.
However, the rules are different for CLTs. If you made a CLT in year one and lived past the seven-year mark, again, there would be no issue as the money would be out of your estate. However, if you were to make another CLT in year 6 and then only lived another 6 years then the second gift would be a failed CLT and, as the CLTs overlapped, the money would be dragged back into your estate. You would, however, still get Taper Relief (depending on how many years you lived).
Therefore, after you have made a gift into a Trust, do not make any other giftsover £3000 in the seven years that follow.
Like all matters related to Estate Planning and Inheritance Tax, experienced advice is essential.
Call us if you require any help.