A recent instance dealing with a clients affairs highlights a common misconception about how taper relief for Inheritance Tax (IHT) works.
Many of you will be aware that Inheritance Tax (IHT) is charged on the value of a person’s estate at the date of death plus gifts made in the 7 years before death. Gifts made more than 7 years before death are not included in the estate. For gifts made between 3 and 7 years before death, there is taper relief which reduces the IHT payable on the gift by between 20% and 80%. It is important to realise that taper relief is only available on IHT payable on gifts and that the IHT nil rate band is allocated against gifts before it is allocated against the estate at death. So unless gifts in the last 7 years exceed the IHT nil rate band (currently £325,000), this taper relief is lost.
These 2 simplified examples, show how this works in practice:
Example 1
Mr.Smith’s estate is worth £500,000 on death. 4 years before he died, he made a gift of £400,000 to his son. Inheritance tax is calculated as follows:
Tax on lifetime gifts:
Chargeable to IHT – £75,000 (£400,000 less £325,000 nil rate band)
IHT tax payable – £18,000 (£75,000 at 40% less 40% taper relief)
Tax on estate at death:
Chargeable to IHT – £500,000 (nil rate band all used on lifetime gifts)
IHT tax payable – £200,000 (£500,000 at 40%)
TOTAL IHT PAYABLE – £218,000
Example 2
Mr.Smith’s estate is worth £600,000 on death. 4 years before he died, he made a gift of £300,000 to his son. Inheritance tax is calculated as follows:
Tax on lifetime gifts:
Chargeable to IHT – NIL (£300,000 less £300,000 nil rate band of total £325,000 nil rate band)
IHT tax payable – NIL
Tax on estate at death:
Chargeable to IHT – £575,000 (£600,000 less £25,000 nil rate band not used on lifetime gifts)
IHT tax payable – £230,000 (£575,000 at 40%)
TOTAL IHT PAYABLE – £230,000
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