Gifts Out Of Normal Income

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Gift

For a gift to make a substantial impact on an estates Inheritance Tax (IHT) liability, it would need to be a large, outright gift.  The person making the gift (the donor) would need to be aware that there is no scope for a “change of mind” if circumstances change, for example if later in life funds become tighter or a conflict arises between the donor and the recipient of the gift (the donee).

Should the donor not survive 7 years from the date the gift was made there is also the issue of the gift being brought back into the donor’s estate.

Exemption

There is, however, an exemption for gifts made as part of normal expenditure from income, which may be more suitable than making one large single outright gift.

To make use of this exemption the donor makes (or starts to make) regular gifts out of their after-tax income, which does not include their capital.  If this series of gifts satisfy the conditions, they are exempt from IHT but these gifts will only qualify if the donor has sufficient income remaining to maintain their normal lifestyle.

Gifts which could form part of the exemption:

  • monthly or other regular payments to someone;
  • regular gifts for Christmas and birthdays, or wedding/civil partnership anniversaries; and/or
  • regular premiums on a life insurance policy for someone else

Maintenance payments to:

  • your ex-spouse or former civil partner;
  • relatives who are dependent on you because of old age or infirmity; and/or
  • your children, including adopted children and step-children, who are under 18 or in full-time education

If gifts out of income are made as part of normal expenditure, extensive records should be kept of after-tax income and regular expenditure.  These records should show that the gifts are regular and that there is sufficient income remaining to cover the gift and the usual day-to-day expenditure, without any need to draw on capital funds.

When an intention to make regular gifts out of normal income is established by written evidence, and supported by other records, such as receipts and bank statements, then even if a donor does not survive for 7 years, the executors of the estate will be able to claim for the payments to be removed from the estate, thus generating IHT savings.

If the gifts are in cash it is important that regularity is established; an easier way of doing this is to pay a bill or a series of bills for the donee.

Gifts out of income can be made in conjunction with the annual exemption of £3,000 which everyone is entitled to make.

Gifts out of income need careful administration so not to leave the executors of the estate with a problem once the donor is deceased.  The advisor should make certain the donor is fully aware that there needs to be precise and accurate documentation of the purpose, frequency and the source of the funds used to make the gifts.  There must be clear proof that the gift comes from excess income and not from capital and HMRC’s approach is that a regular pattern of giving needs to be demonstrated, normally over a period of three or four years. However, there has been case law on the ‘normal’ test.  

In Bennett & Others v Inland Revenue Commissioners [1995] BTC 8003, Lightman J stated “for an expenditure to be ‘normal’ there is no fixed minimum period during which the expenditure shall have occurred”. He added that the existence of a settled pattern of expenditure might be established either by reference to a sequence of payments, or by proof of a “prior commitment or resolution”. HMRC’s definition of “normal” can be found here IHTM14242 and full guidance can be found at IHTM14231 onwards.

Involve an Inheritance Tax Specialist

The intention to make regular gifts out of normal income can be best established by proof of existence of a prior commitment by a legal deed or by establishing a regular pattern of gifts and an IHT specialist will guide the client through the process and ensure as far possible that any challenge is easily rebuffed.

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