What is Exempt from Inheritance Tax?

Broadly speaking, Inheritance Tax (IHT) is levied on the total net value of a deceased individual’s estate. This means that, if the total value of all assets in the estate, less the value of any debts owed, is greater than the Inheritance Tax threshold, IHT will be charged. For the 2009-10 tax year this threshold is £325,000.

Many people use trusts to minimise the Inheritance Tax bill that would otherwise be faced by their beneficiaries. This works by legally separating the individual from part of their estate. However, there are other ways that you can lower your Inheritance Tax bill. The taxman offers exemptions to a number of different transactions.

Exemptions and Potentially Exempt Transfers

To begin with it is important to understand the distinction between exemptions and Potentially Exempt Transfers (PETs). Transactions that are exempt from IHT will never attract tax, regardless of circumstance. For example, assets can be transferred between UK-domiciled spouses or civil partners, and these transactions will never be taxed.

However, other transactions are treated as ‘potentially exempt’. This means that they will not attract tax as long as other criteria are satisfied.

What are the transactions?

The most common Potentially Exempt Transfer is the seven-year gift. Under this rule you can give away money to any individual and, provided that you live for at least seven years after the gift is made, it will not attract Inheritance Tax. On the other hand, if you do not survive the gift by seven years, the sum gifted will be taxed as if it were part of your estate.

Some gifts, however, are always exempt from Inheritance Tax. Certain individuals, known as ‘donees’, can receive gifts of any amount at any time without attracting IHT. These donees are: spouses or civil partners, provided you and they are domiciled in the UK; UK charities; any UK political party, provided they have at least two MPs, or one MP and at least 150,000 votes; and some national organisations like universities and the National Trust.

You should remember that gifts made to a partner that is not your spouse or civil partner will not enjoy any exemption. This is one of the primary arguments in favour of marriage or civil partnership as an act of inheritance planning.

In addition, everyone receives an annual exemption. You can give away assets (including cash) up to a value of £3,000 each year without attracting IHT. You can carry over an unused allowance for one year only; it will expire after that year. This is in addition to any gifts to donees; so you could give £1,000 to a charity and still give away £3,000 to other individuals in the same year without attracting IHT.

Finally, you can also make payments that are judged to be part of your ‘normal expenditure’. These might include, for example, Christmas gifts. Gifts of this type will only be treated as exempt if, after making them, you still have enough money to live as you normally do. Generally speaking, a good test is to consider which account the money has come from; if it has come directly from your current account it is probably exempt.

As can be seen, the rules on exemptions are complex. If you are in doubt about whether or not a gift qualifies for an exemption, you should seek independent expert advice.