Many of our clients want to give money away to reduce their estate and help friends or family, however, are concerned about the rules and want to ensure that they are keeping any gifting legal and above board, and rightly so!

This week, our blog will cover how you can utilise the complex “gifts from income” inheritance tax rules – which effectively allow you to give away surplus income, to anyone, and be immediately outside your estate for inheritance tax.

How the Exemption for Gifts out of Surplus Income Works

In order for a gift to be exempt as a gift out of surplus income, the following conditions must be met:

  • The gift must be part of your normal (i.e typical or habitual) expenditure; and
  • The gift must be made out of your after tax income taking one year with another; and
  • After allowing for all other transfers of value forming part of your expenditure, you are left with sufficient income, in order to maintain your usual standard of living

In order to satisfy H M Revenue & Customs that the gifts were part of your normal expenditure, it will be necessary to show a commitment to make regular gifts as part of a settled pattern of giving. One off / sporadic gifting won’t be allowable.

The exemption only applies where the gifts are made from surplus income after tax.

Examples of income will include pension income, interest from savings, dividend income, rental income or income payments received from a trust.

If you hold life assurance investment bonds and receive regular payments from these, you should be aware that those payments will usually be considered as payments from capital and cannot be included as part of your income.

As a rule of thumb, if you are having to resort to capital in order to meet your usual expenditure, you will not be able to claim that any gifts are made out of surplus exemption as you will not then be able to meet the test that, after allowing for the gifts forming part of your normal expenditure, you are left with sufficient income in order to maintain your usual standard of living.

Some Practical Tips

  • Keep proper records of your income and expenditure will be vital. For those clients that we undertake this exercise with each year for your cashflow forecast, this would be more than sufficient evidence. This way, your executors are easily able to identify your surplus income in any one tax year. If executors require help, Magenta can assist in providing older information in support.
  • If you are planning to establish a pattern of giving as part of your normal expenditure, it is helpful to have this documented. Again, as a Magenta client, this could be as part of a meeting with us (which we Minute) or a recommendation letter, alternatively, you can communicate with the person to whom you are making any gifts as a record of the gift. The communication should cover off your intention to establish a pattern of making gifts out of income to them in the future.
  • Don’t forget to include any non taxable income – such as Attendance Allowance or other state benefits, as they will be considered as income.

In conclusion –  gifts from income exemption is often underused and can be very helpful as an inheritance tax mitigation tool for those that have significant surplus income and are willing to make gifts in their lifetime on a regular basis.

This information is for general information only and does not constitute bespoke personal investment, tax, legal or other forms of advice. You should not rely on this information to make (or refrain from making) any decisions, instead, always contact Magenta to get financial planning advice for your own particular situation.

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