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Gifts out of income

This exemption can be very useful to stop surplus income building up in your estate and increasing your inheritance tax liability. Unusually, the exemption has no upper limit and there’s no requirement to live a further seven years after the gift. But, it only applies to gifts out of income which are part of your normal expenditure, and which leave you with sufficient after-tax income to maintain your usual standard of living.

These requirements can result in a lot of confusion or uncertainty in practice.

Income does not mean taxable income. It includes interest credited to an ISA, but not the 5% tax-free withdrawals from bonds (which strictly speaking are part of the capital originally invested).

‘Habitual expenditure’?

For gifts to form part of your normal expenditure, they must usually be typical or habitual expenditure, and thus some element of recurrence is implied. There’s no requirement for gifts to continue until death (but it is harder for HMRC to challenge them if they do). On the other hand, a single gift made not long before death may still qualify, if the intention to make regular gifts can be demonstrated. One year is considered with another, so the exemption may still be obtained in an abnormal year in which a regular gift wasn’t covered by surplus income.

Normal expenditure includes mortgages, insurance, household bills, council tax, travelling costs, entertainment, standard holidays and nursing home fees. But it might be possible to exclude the cost of a new car or one-off holiday, for example to mark a significant wedding anniversary or birthday.

According to HMRC, “There is no rule of thumb. We basically judge each case on its merits.”

Donors and executors should be aware that the inheritance tax return for a deceased person requires net income (after tax) and regular expenditure to be analysed for the seven years prior to death using form IHT403. Donors might want to complete this form on an annual basis when filing their tax return, as this is likely to save their executor a lot of trouble.

Personal affairs checklist

For a personal affairs checklist visit our website at: www.shipleys.com/files/personal-affairs-checklist.pdf

Specific advice should be obtained before taking action, or refraining from taking action, on the basis of this information.

Need more help? Please contact us at advice@shipleys.com or +44 (0)20 7312 0000