Inheritance Tax (IHT) can impose a significant burden on estates, but understanding available exemptions can help mitigate this impact. One useful exemption is the “gifts out of income” rule, which allows individuals to make gifts without incurring IHT liability. Here’s what you need to know about this exemption and what qualifies as gifts out of income.
What is the ‘Gifts Out of Income’ Exemption?
The ‘gifts out of income’ exemption allows individuals to make gifts from their surplus income without those gifts being counted as part of their estate for IHT purposes. This means that as long as the gifts are made from income rather than capital and meet certain conditions, they can be excluded from the estate’s value when calculating IHT.
Key Conditions for the Exemption
- Made from Surplus Income
To qualify for the exemption, the gifts must come from surplus income. This means the donor must have enough income remaining after covering their usual living expenses. For example, if an individual earns £50,000 annually and has living expenses of £30,000, the surplus income available for gifting is £20,000.
- Regular Payments
The gifts should ideally be made on a regular basis (e.g., monthly or annually) rather than as one-off payments. This could include payments made to family members, friends, or charities.
- Documentation
It’s essential to keep detailed records of the income, expenses, and gifts made. This documentation will be crucial in proving to HMRC that the gifts were made from surplus income and qualify for the exemption.
- No Limit on Amounts
There is no maximum limit on the amounts that can be gifted under this exemption. However, it’s important to ensure that the gifts are sustainable based on the donor’s income and living expenses.
What Counts as ‘Income’?
To qualify for the exemption, the gifts must be made from income sources, which can include:
- Salary or Wages: Regular earnings from employment or self-employment.
- Pension Income: Payments received from personal or occupational pension schemes.
- Investment Income: Interest, dividends, or rental income from investments or property.
- Annuities: Payments received from annuity contracts.
Examples of Gifts Out of Income
- Monthly Family Support: A grandparent gives their grandchild £200 every month to help with living expenses, funded from their surplus pension income.
- Annual Charitable Donations: An individual donates £5,000 each year to their chosen charity, using their excess income after paying living expenses.
- Regular Gifts to Friends: A retired individual regularly gifts £1,000 to a friend each year from their investment income, having documented their surplus income.
Conclusion
The ‘gifts out of income’ exemption provides a valuable opportunity for individuals to reduce their potential IHT liability by making gifts from surplus income. By understanding the qualifying criteria and keeping accurate records, donors can effectively use this exemption to benefit their loved ones while minimizing their estate’s tax burden.
For more detailed guidance on Inheritance Tax and available exemptions, visit the HMRC Inheritance Tax page.
For Help with Topic above or any Accountancy help – contact us: