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Tax Tip 5: Potentially Exempt Transfers (PETs) – What happens when you give away assets in your lifetime?

PETs are ‘potentially exempt’ because if you survive them by 7 years they do not form part of your estate when calculating Inheritance Tax (IHT) on death.

However, if you die within 7 years of making a gift, some or all of the gift can form part of your estate for IHT purposes.

Lots of our clients are aware that tapering applies on a lifetime gift, as long as you have survived the gift by 3 or 4 years. The practical application is not as straightforward as you may imagine and often catches people out.

When considering a lifetime gift made less than 7 years ago, we must first apply any other allowances or exemptions that are available such as the annual exemption.  Please see yesterday’s tax tip for more information on allowances and exemptions.

The remaining value of the gift, after the deduction of exemptions will be added back into your estate when calculating the IHT due on your death. In practice, the value of this gift will use up some or all of your Nil Rate Band (NRB).

IHT will not be due on the value of the gift itself unless there was no NRB available due to earlier lifetime gifting or if the gift itself was over the NRB. 

It is important to note that tapering does not apply to the gift itself but instead only to the tax charged on the gift. Therefore tapering will only occur if you have gifted more than £325,000 (the NRB)to non-exempt beneficiaries in the 7 years prior to your death.

Tapering on the tax is calculated as follows:

Years since the gift

Tax Rate

Less than 3

40%

3-4

32%

4-5

24%

5-6

16%

6-7

8%

7 or more

0%

This is best explained by way of an example.

John regularly uses his annual exemption. He gifts £500,000 to his daughter to help her buy a house. John dies 5 and a half years later.


Value of gift  £500,000 
Available Exemptions  £0
Less NRB  (£325,000)

Chargeable value of gift for IHT purposes £175,000

IHT would usually be due at a rate of 40% leading to a tax charge of £70,000 however as John survived the gift by 5 and a half years, we can apply the lower tax rate of 16% leading to a tax charge of £28,000 instead. 

 

These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.

 

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