Normal expenditure out of income – A valuable IHT relief

Just over a year ago we covered 10 top tips for inheritance tax planning (IHT) and, in this Tax Tuesday, we are going to consider one of these in more detail.

‘Normal expenditure out of income’ is a valuable exemption which is often overlooked. When used effectively, it can be a very valuable tax relief.

Broadly, in the absence of any reliefs, the donor of a gift to another individual must survive seven years from the time of the gift for it to fall out of the reckoning for IHT purposes.

As IHT is charged at rates of up to 40%, it can be a very punitive tax in the absence of any planning.

As an example, take an individual who makes a gift of £20,000 to their son or daughter and then dies a year or two later.

In the absence of relief and assuming their ‘nil rate band’ for IHT (which depending on the circumstances can take the first between £325,000 and £500,000 of value charged on death out of the tax net) has been used elsewhere, there will normally be a £8,000 IHT liability to pay on death on this gift alone.

If instead the £20,000 gift qualifies as a normal element of the donor’s expenditure and the gifts do not require the donor to have to reduce their ongoing standard of living then these could qualify as being exempt from IHT.

The gifts must be part of a regular pattern of giving from one year to the next but there is no overall limit on the value of gifts which can qualify under this exemption which is why it is potentially such an important relief.

In addition, the gifts can be of different amounts at different intervals and to a variety of recipients.

Generally the pattern of giving must be sustained over three to four years but there are exceptions to this.

For instance, if only one gift is made before death but there is evidence to show this was the first of many intended gifts out of the taxpayer’s income, then this could be enough to claim the exemption.

As mentioned above, the donor must not be forced to adjust downwards their standard of living as a result of the gift and neither can they start to use their own capital to replace use of income in order to maintain their existing lifestyle.

Taxpayers using this exemption should keep good records to show the gifts which it is intended will qualify can clearly be shown to be made from surplus income left once normal expenditure has been met. Following death, the IHT forms which need to be submitted ask for this information and so it will save time and expense if these details are readily available.

Questions about tax planning? Contact your usual relationship principal, email or call 0161 905 1616.

The author takes every care in preparing material to ensure that the content is accurate and up to date. However no responsibility for loss occasioned to any person acting or refraining from acting as a result of this material or from making use of this material can be accepted by the author.