There are a number of exemptions when it comes to gifting and inheritance tax. Here, we are going to focus on the ‘normal expenditure out of income’ exemption or sometimes called gifts out of surplus income, which is probably one of the most valuable exemptions but often underused.
You may have heard of the 7- year rule. Gifts made to individuals are called ‘potentially exempt transfers.’ There is no charge to inheritance tax at the time you make the gift, and it is treated as fully exempt if you survive 7 years from the date of the gift. However, if you die within the 7-year period, the value of the gift will be added to your estate on your death for inheritance tax purposes.
The ‘normal expenditure out of income’ exemption is particularly useful as the 7-year rule does not apply, as long as the gifts meet certain requirements. So, what are the requirements?
- The gift formed part of the transferor’s normal expenditure – this can mean either a pattern of regular gifts or the intention to make regular gifts. You should therefore record when you are making a gift out of income, by writing a letter for instance.
- The gift is made out of income; and
- The transferor (the person making the gift) is left with enough income for them to maintain their normal standard of living.
In order to assess whether you have sufficient income to utilise this exemption and to satisfy conditions 2 and 3, you will need to:-
- Consider how much net income you receive (for example, from employment, pensions, dividends, interest, rent) after tax
- Review what your normal expenditure amounts to – there is no actual legal definition of what ‘normal expenditure’ amounts to but is based on an individual’s particular circumstances. This of course may fluctuate from year to year.
We would therefore advise completing this exercise each tax year to review how much surplus income you have for that year. You can then increase or decrease the amount you gift accordingly.
There are no hard and fast rules as to when income no longer retains its status as income. However, the Revenue tends to take the approach of being able to carry forward income for a period of two years.
The inheritance tax form 403, provides a useful record keeping tool.
Your executors will need to claim the exemption on your death, and therefore it is important to maintain thorough record keeping.
Take away points
- Review whether you have surplus income each year and maintain thorough record keeping
- Confirm in writing when a gift is made using surplus income, possibly by way of a letter or note.
How we can help
We can help to review whether you are able to utilise this exemption, at the same time as reviewing your general estate planning and/or reviewing your Will.
Please do not hesitate to contact me or a member of the Private Client Team.
