Using inheritance tax (IHT) exemptions and reliefs is crucial if you want to reduce the amount of IHT payable on your death. One of the most useful, yet least used, lifetime exemptions is the ‘normal expenditure out of income’ exemption.
This exemption can be of great benefit to individuals with surplus income as there is no upper limit on the amount that can be gifted from your income. As there is no requirement to survive a certain number of years following the gift, the benefit of the exemption is realised instantly and has the potential to save a significant amount of IHT.
The exemption can be used if the gifts:
- are made as part of your normal expenditure;
- are made out of your income; and
- leave you with enough income to maintain your normal standard of living.
For the exemption to apply, the taxpayer must demonstrate a regular pattern of giving over a reasonable period of time. Where the taxpayer has not managed to establish a pattern – for example, where only one gift has been made – the exemption can still apply if evidence can be provided of an intention to make further gifts. A letter of intent is therefore advisable at the outset.
There are qualifications to the exemption. Certain types of income cannot be gifted, for example, annuities and insurance bond pay-outs. Any surplus income must be gifted promptly, otherwise the income will be considered as capital.
Successfully claiming the exemption can be complex. HMRC require detailed evidence for a claim to succeed. Page eight of Form IHT403 – available to download from the government’s website – can be used to keep a record of gifts, income, and expenditure by an individual. This information provides evidence that the gifts were made as part of the individual’s normal expenditure. Using this form when the gifts are being made is important to avoid difficulties in claiming the exemption at a later stage.
Ensuring assets are gifted in a tax efficient way can help save your loved ones a significant amount of IHT.