By Andrea Pierce, Owner of Andrea Pierce Probate Services
Andrea Pierce is a qualified Solicitor and Trust and Estate Practitioner (Society of Trust and Estate Practitioners). Andrea previously worked as the Legal Services Director for a national business providing probate and estate administration and has over 18 years of experience in probate and estate administration.
Potentially Exempt Transfers (PETS) and Taper Relief suffer from some common misconceptions, which I will address in this article.
PETS are also known as the seven-year rule meaning there is no Inheritance Tax due on gifts that the Donor makes, providing they live for seven years after making the gift. The exemption to this is if the gift is made to a Trust which may be immediately chargeable to Inheritance Tax, which is known as a Chargeable Lifetime Transfer.
In relation to PETS, if the Donor of the gift does not survive seven years, then the gift made may be taxable on death if either the gift itself or the cumulative effect of previous gifting exceeds the Nil-Rate Band allowance. The amount of Inheritance Tax (IHT) due on the gift(s) depends on when it was given.
Any gift made within the preceding three years before death may be taxed at the usual rate of 40%. For any gifts given three to seven years before death, they may be taxed on a sliding scale. This is known as ‘Taper Relief.’
Taper Relief scale
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Gifts made between three and four years before death: 80% of the IHT will be payable (rate of IHT on the gift is 32%)
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Gifts made between four and five years before death: 60% of the IHT will be payable (rate of IHT on the gift is 24%)
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Gifts made between five and six years before death: 40% of the IHT will be payable (rate of IHT on the gift is 16%)
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Gifts made between six and seven years before death: 20% of the IHT will be payable (rate of IHT on the gift is 8%)
A common misunderstanding is that Taper Relief is applicable on any size gift made in the preceding three to seven years before death. Unfortunately, this is incorrect because Taper Relief is only applicable if the Donor has given away more than £325,000 in this time frame. A deceased individual may have gifted money within the timeframes for Taper Relief to be applicable, but the sum given away must exceed the Nil-Rate Band allowance as gifts made erode this first; in the order that they were gifted. That said, it will be necessary to ascertain if any gifting took place in the seven years prior to the oldest gift made, because if a gift was a Chargeable Lifetime Transfer, this may erode the availability of the Nil-Rate Band allowance (this is known as the 14-year rule) to the oldest PET within seven years, and thus, Taper Relief may indeed be applicable.
An illustration is as follows to demonstrate this:
James died on 1 April 2024
He made the following gifts during his lifetime:
Gifts 1 and 2: There’s no Inheritance Tax to pay on these gifts as they were made more than seven years before James died.
Gift 3: Although this was made more than seven years before death, because it is a Chargeable Lifetime Transfer, this gift will be taken into account when calculating the availability of the Nil-Rate Band allowance for Gift 4.
Gift 4: Gift 3 will erode the available Nil-Rate Band allowance, but as this gift is still within the allowance there is no IHT payable on this gift. Calculation: £325,000 - £150,000 (Gift 3) - £100,000 (Gift 4) = £75,000, this being the Nil-Rate Band allowance available.
Gift 5: As only £75,000 is available from the Nil-Rate Band allowance, this means that £25,000 is taxable. It is possible to apply Taper Relief to this gift because it takes the totality of the gifts over the Nil-Rate Band allowance. This means £25,000 would be taxed at the reduced rate of 8% as it was made between six to seven years before death.
Gift 6: The Nil-Rate Band allowance has been used up by the prior gifting. As this gift was made a year before death, the tax payable is at 40%.
*Please note for the ease of the calculations, no annual allowance has been taken into account with the gifting.
From a best practice point of view, if your clients are making gifts then they should be encouraged to make a list that is readily available for their Personal Representative(s) for inclusion in the IHT400.
This article is featured in the autumn 2024 edition of our quarterly news digest, Entitlement. Download your free copy of Entitlement for more informative articles.
Topics: Entitlement, Guest writer, Taper Relief
