Forget the 7 year rule! Do you know about the 14 year rule?
Inheritance tax (IHT) is big news right now. With the new changes being phased in from April 2017 whereby the Government has introduced “the family home allowance” which is worth up to an additional £175,000 per person, the gradual change amounts to £100,000 in 2017-18, £125,000 in 2018-19, £150,000 in 2019-20 and £175,000 in 2020-21.
Currently, every individual is entitled to pass on £325,000 of wealth tax free, irrespective of whether or not they own a property under the tax-free threshold, or “nil-rate band” (NRB). Any assets in an estate that supersede this amount incur an IHT charge. Married couples and civil partners are still entitled to the usual allowance (£650,000) before tax becomes payable and the existing £325,000 individual NRB will remain frozen until at least the end of 2020-21. However, the new allowance for property owners equates to £500,000 for individuals or £1million for couples.
Anyone with an estate valued at over £2 million however will lose some of the family home allowance, which will subsequently be tapered at the rate of £1 for every £2 over the £2 million threshold.
Presently, anyone making a gift through outright transfers of values of assets, has to survive a period of at least seven years for that gift to remain free of inheritance tax. Any gifts that are made during that period are known as ‘potentially exempt transfers’ (PETs).
This is where it becomes complex. If a person dies within that seven year period, any gifts that were made in the previous seven years before the establishment of a trust would also form part of the calculation of inheritance tax. So, any gifts made up to 14 years before death can attract the tax. Were you aware of this or if you are, have you informed your clients? A PET is reassessed and added to any other taxable gift that someone has made in the seven years prior to making a PET. This has to happen to see whether any tax is then due on the PET itself meaning that any gifts made during those 14 years prior to death could still be relevant.
An example of such; if a person made a Chargeable Lifetime Trust (CLT) in 2007 they would have had an NRB of £300,000. If they had made a previous transfer to the trust in 2004 of £100,000 then the available NRB would have been £200,000. Comparing that available NRB with the amount of the current CLT, if the current CLT exceeded the NRB then the excess would have been taxed at 20%. Prior to March 2006, this only applied to transfers to discretionary trusts, but now after this date transfers to all trusts (aside from trusts for a disabled person) will be classed as CLTs.
When tax becomes due on a PET, the person who received the PET will be asked to pay the tax. However, the tax due may be reduced because of ‘taper relief’.
This is how taper relief may reduce tax due on PETs:
- If the gift was made less than three years before death, no reduction in tax is due
- If the gift was made three to four years before death, tax is reduced by 20%
- If the gift was made four to five years before death, tax is reduced by 40%
- If the gift was made five to six years before death, tax is reduced by 60%
- If the gift was made six to seven years before death, tax is reduced by 80%
What advice would you give or are you giving to your clients surrounding the 14 year IHT rule?
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