February 12, 2022
By Michael Lester
As is widely understood some gifts are considered to be immediately free from inheritance tax.
In respect of those gifts not immediately outside of an estate, the donor (settlor) needs to survive the making of the gift by 7 years in order that these gifts have no impact on their inheritance tax liability. In cases where the donor does not survive the 7 years, then the value of the gift(s) made are set against the inheritance tax free limit, also referred to as the Nil Rate Band (NRB), that is in force at the date of their death.
By way of example, an individual makes gifts adding up to £50,000 in the 7 years prior to death, which did not qualify as being immediately outside the estate. If at the date of death, the NRB is £325,000 (as now), then the value of the gifts made, £50,000 is set against the £325,000 meaning that the amount of NRB available to the executors to set against the estate value is £275,000 (£325,000 minus £50,000). This shows that the age of the gift has no impact on the inheritance tax liability because gifts that amount to be within the NRB simply reduce the usable NRB available.
Let us now compare the tax treatment where gifts are above the NRB. Let us consider gifts totalling £500,000. We now know that with gifts below the NRB the gift will never be subject to inheritance tax because it is covered by the donors tax free threshold. However now we have a gift where a proportion of the value is above the NRB. In such circumstances the potential tax liability created by the gift is deemed to pass to the donee (recipient) and any future tax liability becomes the responsibility of the donee.
So, in this example of the £500,000 gift the first £325,000 of any tax liability will be covered by the NRB of the donor. However, the balance of £175,000 carries with it a potential tax liability of up to 40% should the donor die within the next 7 years.
It is in these circumstances alone, where a potential tax liability arises because of the value of the gift, that Taper Relief might apply. The Taper Relief rules state that if the donor dies inside the first 3 years then the tax rate applied remains at 40% which would amount to £70,000 in this example. However, if the gift is older than 3 years then the rate of tax is reduced (tapered) and a lower rate of tax is applied. The rule is that the tax rate reduces by 8% for each year beyond 3 years.
The easiest way to assess if Taper Relief applies is to add up the value of the gifts being considered and if the value of these are below the nil rate band then, there will be no taper relief available.
The chart below provides a table showing the impact of taper relief together with the tax liability on a gift of £500,000.
|Age of Gift||Amount of Taper Relief Applied||Effective Tax Rate||Tax Due in Example|
|1- 3 years||0||40%||£70,000|
|3 – 4 years||8%||32%||£56,000|
|4 – 5 years||16%||24%||£42,000|
|5 – 6 years||24%||16%||£28,000|
|6 – 7 years||32%||8%||£14,000|