Inheritance Tax: The 14-year rule

5th November 2019 Wills, Trusts & Estate Planning

The Office for Budget Responsibility published a report earlier this year which found that Inheritance Tax is expected to raise £5.3billion in 2019-20 which is equivalent to 0.7% of the total UK tax receipts. This figure is expected to raise to £6.3billion by 2023-24. So, despite the welcomed introduction of the Residence Nil Rate (RNRB), Inheritance Tax revenue growth has seemingly not been stunted.

Every individual is currently entitled to a “Nil Rate Band” (NRB) of £325,000 with any assets in excess of this amount being taxed at a rate of 40%. So, if your estate is worth £450,000 on your death, £325,000 of this will pass tax-free with the remaining £125,000 being taxed at 40% unless covered by the RNRB. This would leave an Inheritance Tax bill of £50,000 to be paid from your estate.

However, there are various exceptions to this. For example, any assets passing to (or on certain trusts for) a spouse or civil partner are exempt from Inheritance Tax. On death, spouses and civil partners can also pass on their unused NRB and RNRB to the surviving spouse or civil partner meaning that couples could potentially pass up to £1million tax free (with the RNRB increasing to £175,000 per person from April 2020).

Furthermore, any gifts made during your lifetime may have reduced the NRB that is available to you on your death.

When making any outright transfer of assets to children or other family members which are in excess of the £3,000 annual allowance, an individual must survive seven years for the gift to fall out of their estate for Inheritance Tax purposes. Gifts made within this timeframe are known as “Potentially Exempt Transfers” (PETs). If the transferor dies within the seven year period then the transfer will become chargeable.

Another type of transfer, known as a Chargeable Lifetime Transfer, involves an individual transferring assets into certain discretionary trusts. A CLT is immediately chargeable to Inheritance Tax and there will be tax to pay if, in the seven years prior to the CLT, the individual has already used up their NRB. The lifetime charge rate of Inheritance Tax is 20%. However, if the transferor dies within the 7 years of the CLT, the Inheritance Tax due on the CLT must be recalculated at the death rate of 40% over the NRB. The tax already paid is deducted but the difference will now be payable. Please note that tapering relief will apply in some circumstances.

Every transfer that becomes chargeable or rechargeable has its own cumulation period. This consequence of this is that an individual who makes a CLT may in fact have to survive 14 years before it stops having an impact.

So, as an example: Enrique dies in September 2017 having made various gifts during his lifetime. In November 2011 he gave his daughter £200,000 outright and prior to this, in May 2006, he transferred £250,000 into a discretionary trust.

The November 2011 PET is now chargeable as it was made in the seven years prior to Enrique’s death. The PET now has its own cumulation period and so we must look back seven years from the PET to see if any CLTs were made. As we know, Enrique transferred £250,000 into a discretionary trust in the seven year period prior to the PET.

This means that we must take the CLT into account for cumulation purposes meaning that there is only £75,000 NRB available for the 2011 PET (assuming that Enrique used his annual allowances). The transferee will therefore be liable to pay Inheritance Tax on the failed PET. Again, please note that taper relief should apply.

Careful, forward planning with the use of gifting and transferring assets into trust is a very effective strategy for reducing your Inheritance Tax bill. However, as we can see, the rules around Inheritance Tax are very complex and common misconceptions can lead to unintended financial consequences. If you would like any advice regarding Inheritance Tax and lifetime gifting then please contact us on 0345 872 6666 or through our online enquiry form.

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Shelby Munn is a Paralegal located in Manchesterin our Wills, Trusts and Estate Planning department

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