Estate Planning Guide

When income is actually a return of capital For example, if an individual gifts money from a Discounted Gift Trust or gifts from income subsidised from a Discounted Gift Trust, the payments made are actually from a return of capital and not income. 32 ESTATE PLANNING OPTIONS 33 ESTATE PLANNING OPTIONS for the exemption just because a more frugal person would have had surplus income. Examples given by HMRC of normal expenditure include, regular premium payments on an insurance policy for another person and monthly or other regular payments to someone including gifts made at Christmas, birthdays or wedding anniversaries. HMRC’s advice is for the donor to keep a record, such as a simple account of net income and expenditure for the tax year, together with details of the gifts made. If circumstances change, a person can stop making the gifts without losing the exempt status of those already made as long as they qualified. Additionally, while this exemption is usually deliberately achieved as a result of tax planning advice, there is always the possibility that anyone making regular gifts for several years before their death may inadvertently achieve the exemption conditions, so it is worth checking. Gifts out of income can be used in conjunction with other gift exemptions and with trusts. We judge each case on its merits. We do look closely at the standard of living of the transferor. The test of normality requires patterns of giving to be established. HMRC Gift allowances Gifts to spouse or civil partner As a general rule, transfers between spouses are exempt from IHT. However, a limited spouse exemption of £325,000 applies to transfers from a UK domiciled individual to a non-domiciled spouse. This limit was £55,000 prior to 6 April 2013. Since 6 April 2013, it has been possible for a spouse who is domiciled outside the UK to make an election to be treated as UK domiciled for IHT purposes, enabling them to benefit from unlimited IHT spousal exemption in respect of gifts and bequests received from the UK-domiciled spouse Regular gifts out of normal income (after tax) The gift must have formed part of the transferor’s normal expenditure and left the giver with enough income to maintain his/her normal standard of living. Gifts up to £250 Up to £250 per person, including other IHT exempt gifts such as a wedding gift or gift that counts towards the annual exemption Wedding/Civil Partnership gifts Up to £5,000 to a child, £2,500 to a grandchild/great grandchild, £1,000 to anyone else. These must be given on or shortly before the event. Annual exemption Up to £3,000 worth of gifts per tax year. This can be carried over from the previous tax year, with a maximum exemption of £6,000. Gifts or bequests for national purpose or public benefit Including gifts to UK-based charities, political parties, universities. Payments to help with another person’s living costs This might apply to an elderly relative or a child under 18. Gifts Out of Income Regular lifetime gifts out of after-tax income are immediately exempt and for IHT purposes this makes it irrelevant whether or not the donor survives for seven years or what the individual’s available NRB is. For the exemption to apply, it is claimed by the executors after the death of the donor and it must be shown that a transfer of value meets three conditions: • It formed part of the transferor’s normal expenditure and was regular. Evidence of an intention to make regular gifts over a period of time should be available. This could be in the form of a letter stating the intention to make the gifts, or a pattern such as the payment of annual premiums on a life policy for the benefit of someone else. HMRC suggests that a reasonable time span for intention to make gifts would normally be three to four years. But the amount or the beneficiary of the gifts can vary, as long as the beneficiary is the same class of person (e.g. children) and the intention or pattern is clear. It must not be made from capital. • It was made out of net income after tax such as salary, commissions or rent received, dividend income from shares, and interest paid on a bank or building society account, ‘taking one year with another’. This means on the basis of a normal year so that a one-off bad income year that causes an interruption to the gift pattern will not result in loss of the exemption, assuming the gifts then recommence. HMRC will likely consider accumulated income as becoming capital after two years, so gifts made out of older accumulated income should be carefully considered. • It left the transferor with enough income to maintain his/her normal standard of living without resorting to capital to meet living expenses. So, a person who spends all his/her income cannot say that his/her gifts qualify