A little-known tax loophole has been a guardian angel to some British families, helping them shield tens of millions from the clutches of inheritance tax (IHT). The Telegraph reports that last year alone, a modest number of 430 families managed to safeguard a whopping £67 million from death duties, thanks to the “normal expenditure out of income exemption.” This exemption allows people to give away unlimited gifts completely free of IHT during their lifetime.
A Hidden Gem in The Tax Law
As property prices rise and tax thresholds remain rooted, inheritance tax is snagging more and more families in its net. The number of estates hit with an IHT charge soared to a 20-year high of 41,000 in 2022, a stark rise from 33,000 the previous year.
One common respite has been the £3,000 annual exemption, allowing each person to give away up to this amount yearly without attracting IHT. However, nestled within the tax laws, the “normal expenditure” rule seems to be a pot of gold yet to be fully discovered. Despite its potential to shave off a substantial amount from IHT bills, recent figures from HM Revenue & Customs reveal it’s been sorely underused.
Over the past five years, only 2,490 taxpayers leveraged this exemption, cutting their IHT bills and passing on a total of £304 million free from IHT. In the last year, a mere 430 families hopped on this tax-saving train, but their combined saving was a staggering £67 million.
Could You Be Missing Out?
Financial expert Sean McCann from NFU Mutual describes this exemption as one of the most potent yet lesser-known. It’s an open invitation to give away excess income immediately free from IHT, halting the monthly growth of your inheritance tax liability.
To unlock this exemption, one needs to adhere to the rules stipulated under Section 21 of the Inheritance Tax Act 1984. The exemption allows taxpayers to gift any amount, provided it aligns with their “normal expenditure.” This means the gifts should not compromise the donor’s living standards and must come from their income—this could be pensions, dividends, interest, rent, or salary.
Furthermore, meticulous record-keeping is paramount to separate the gifts from normal expenditure and those part of the £3,000 annual gift allowance, especially when making a claim using the IHT403 form.
Pitfalls to Avoid
However, there’s a thin line to tread. If, after making the gifts, the donor has to dip into their savings to get by, the taxman is likely to dismiss the claim. The gift then morphs into a “potentially exempt transfer” (PET), which could attract the usual inheritance tax if the donor dies within seven years of making the gift.