When you die, Inheritance Tax (IHT) is charged on the value of your estate to the extent that it exceeds the nil rate band (NRB) then in force. The NRB is currently £325,000. There may be exemptions to apply which will reduce the tax liability, for example where assets are left to a surviving spouse or charity, or business or agricultural property relief may be available.

However, it is not only the value of the assets which you own that are included in the IHT calculation. Any gifts made within the last 7 years of your life also have to be added back to the estate. Again, there are exemptions which can reduce the value of gifts to be brought into account.

Briefly, the main exemptions which apply to gifts are:

1. Annual exemption – each individual can give away £3,000 per year free of IHT irrespective of how long they then survive for. In addition, if you have not used your exemption in the previous tax year, you can carry it forward for one year allowing you to make gifts of up to £6,000 in the current tax year;
2. Gifts on marriage – there are exemptions for gifts made on marriage which vary depending upon your relationship to the bride and groom. A parent can give £5,000 to their child on marriage free of IHT, either party to the marriage or a grandparent or remoter ancestor can give £2,500 free of IHT and anyone else can give £1,000;
3. Small gifts of up to £250 per year to any one person are free of IHT; and
4. Normal expenditure out of income covers gifts which are made out of excess income each year. These gifts can be up to any value but have to be made from income and be made as part of the donor’s normal expenditure (the best way to establish these gifts is by a regular pattern).

If the above exemptions do not apply, then the value of the gift (made in the last 7 years) is added to the value of the estate when calculating the IHT payable on death.

Doesn’t the gift taper after 3 years?

This is a question which we get commonly asked. The answer is “no”. There is a taper which applies after 3 years but this does not taper the value of the gift only any tax payable on the gift. The tax tapers by 20% per annum after 3 years has passed. Therefore, if the donor survives 3 years only 80% of the tax is due, after 4 years only 60% of the tax is due and so on to year 7 when no tax is due.

This is best illustrated by way of example.

Assume a gift of £400,000 is made in December 2011. The donor dies in December 2015 with an estate worth £500,000.