Inheritance tax explained by Interactive Investor expert
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The inheritance tax (IHT) 14 year rule essentially means gifts made 14 years ago could be dragged back into the tax equation. Senior personal finance analyst for Hargreaves Lansdown, Sarah Coles, shared just how the rule works and the “horrible surprises” it could hold.
IHT is an inherently complicated topic, and reforms for its simplification were shelved in late 2021.
The Office of Tax Simplification was commissioned in 2018 to review IHT and in its first five year review, only one of its 12 suggestions is due to be implemented.
As of January 1, 2022, over 90 percent of non-taxpaying estates will not need to complete IHT forms for deaths when probate or confirmation is needed.
Amongst the other suggestions was the recommendation to simplify the lifetime gift exemptions and change the scope of reliefs for IHT.
These aspects of IHT have not been updated in the last three decades, with Britons losing £7,000 through annual exemption relief which has not been updated since 1981.
Had the relief maintained levels with inflation it would currently sit at £10,000 rather than the actual £3,000.
The current system has also been criticised for taking too long for large gifts to leave the estate, which is where the 14 year rule comes into play.
Ms Coles told Express.co.uk: “Reducing the length of time it takes for larger gifts to leave the estate from seven to five years was also eminently sensible, as the current system requires too much record keeping, and forward planning.
“And getting rid of the loophole that means gifts made 14 years ago could end up dragged back into the estate would have avoided some horrible surprises.”
As the current rule maintains seven years, if an individual dies within seven years of giving a large gift then one must also look seven years before the original gift was made.
Ms Coles explained: “It’s where someone has made a gift to a trust, and then subsequently makes a gift to an individual, and then dies within seven years of giving the gift to the individual.
“You then have to look back to the seven years before the gift was made to the individual, and consider any gifts made to trusts. If the gift was made to the individual almost seven years ago, this means looking back almost 14 years.”
For example, the below timeline was used in the consultation:
December 2009: Ellen makes a gift of £325,000 into a trust.
January 2013: Ellen makes a gift of £20,000 to Trisha.
March 2018: Ellen dies.
Calculating IHT on Ellen’s gift to Trisha in 2013, gifts from the preceding seven years must also be taken into account.
In this case, the gift to the trust would be dragged into the equation despite being made almost a decade before Ellen’s death.
The gift to the trust in 2009 would use all of the nil rate band and, ignoring taper relief, there would then be a £8,000 IHT bill payable on the gift to Trisha.
Ms Coles concluded: “It’s so complicated that it’s no wonder so few people understand it!”
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