Giving away surplus income as a gift to family members is often promoted as an excellent way of planning for the future and as a way of reducing liabilities on a person’s estate. But how do the rules regarding gifts work in practice?
Gifts provided from surplus income – i.e. income less usual expenditure to maintain your client’s standard of living – are not considered as a remaining part of a person’s estate, regardless of how long they survive for following the gift and should, therefore, be free of inheritance tax (IHT).
Under the current rules, there is no limit on the amount that your clients can give away as a gift out of income, but it is recommended that a letter of intent is prepared when making such regular gifts.
This can be provided to HM Revenue & Customs (HMRC) in the event of a short period of giving due to a change of personal circumstance. In addition, there is no requirement for the donor to survive seven years for the gifts to be free of IHT, unlike lifetime gifts.
Where gifts are to be made to a minor, and regular payments may not be appropriate, then a discretionary trust into which the payments are made might be more suitable.
Normally, there is IHT on the transfer of income into the trust if the nil rate band is exceeded, although the accumulated income in trust will not use up the Nil Rate Band. However, this does not apply where regular gifts out of income are made.
Please remember that there is an IHT charge every 10 years based on the value of the trust’s assets at the date of the 10 year anniversary and the maximum tax rate is six per cent.
The 10 year charge can be avoided by distributing the assets in the trust prior to the 10 year anniversary of the trust. Alternatively, a number of different trusts could be set up with the amount invested into each trust restricted so that the nil rate band is not exceeded at the 10 year anniversary of the trust. However, the growth in the value of the assets in the trust would need to also be taken into account.
The trust should have no other assets in addition to the regular gifts out of income and each should be set up on a different day, as multiple trusts set up on the same day are aggregated for the purpose of determining whether the Nil Rate Band has been exceeded at the 10 year anniversary.
Those clients considering giving away surplus income should keep a record of the gifts and record their income in the fiscal year, including expenses, as this would be required by the executors to ensure no inheritance tax is payable.
At Vale West, we are happy to provide you and your clients with advice on the most tax effective methods of gifting income and assets. For more information, please contact us today.
