Throughout your lifetime, you may feel inclined to share your wealth with friends and family. However, making large Gifts to loved ones can often come with even larger tax implications.
There are numerous rules and regulations to consider before you make a transfer of value, so it’s important to be informed before you make any important decisions.
An IHT Potentially Exempt Transfer is a great way to ensure your Gifts are received as you intended. In this blog, we’ll explore what they are and how they can be used to your advantage.
What is a Potentially Exempt Transfer?
A Potentially Exempt Transfer (PET) is a lifetime Gift with the potential to be free of Inheritance Tax (IHT). These transfers of value encompass Gifts such as property, money, and possessions.
There is no Potentially Exempt Transfer limit when it comes to the value of these Gifts. PETs can be made to any individual and at any given time, however, they must follow the 7 year rule in order to be exempt from Inheritance Tax.
The 7 year rule
In essence, there is no IHT to pay on Gifts of any value if the benefactor survives seven years after making the Gift. This is known as the 7 year rule.
If the benefactor passes away three years before making the Gift, the value will be taxed at a standard rate of 40%.
However, if they die between three and seven years, the transfer will be taxed on a sliding scale known as the Potentially Exempt Transfer taper relief.
Exceptions to the rule
As with most financial exchanges, there are exceptions to Potentially Exempt Transfer rules. More specifically:
- Civil partnerships and marriage - transfers of any value between civil partners or married couples do not count as Gifts and therefore they are not subjected to Inheritance Tax in the UK.
- Annual exemption - each year you have a tax-free Gift allowance of £3,000 and, if unused, you can carry this forward once to benefit from a £6,000 allowance.
- Small Gifts - each year you can make small Gifts of up to £250 to different individuals without having to pay any tax.
- Gifts to political parties and charities - donations and Gifts made to political parties or charities are exempt from Inheritance Tax.
- Child maintenance or education payments - if children are under the age of 18 or enrolled in full-time education, transfers issued by parents for child maintenance or education matters will not be regarded as Gifts or subjected to Inheritance Tax.
- Income expenditure - you can make regular tax-free Gifts to individuals from any surplus income you acquire as long as these transfers do not affect your lifestyle.
- Wedding Gifts - as a parent, you can Gift your children up to £5,000 as a wedding or civil partnership Gift. Grandparents are given a £2,500 tax-free Gift allowance and Gifts to other relatives or friends have a tax-free allowance of up to £1,000.
When is a PET chargeable?
As outlined by the 7 year rule, Potentially Exempt Transfers are only chargeable when the benefactor passes away within seven years of making the Gift. Therefore, there is no IHT to pay at the immediate moment.
Similarly, a PET is only chargeable when the Gift surpasses the £325,000 tax-free threshold of the transferor.
So, when it comes to a chargeable Potentially Exempt Transfer who pays the tax? The recipient will need to cover the costs incurred by Inheritance Tax.
How to make a Potentially Exempt Transfer
To make a Potentially Exempt Transfer, you simply need to make a Gift of any value to an individual. This Gift can be made at any time and may consist of property, money, or possessions, such as jewellery or antiques.
There are some additional conditions outlined by the Potentially Exempt Transfer HMRC guidelines. For example, the transfer must be made to another individual or specified trust and the Gift must be made by an individual on or after March 18th of 1986.
What’s the difference between Exempt Transfers and Potentially Exempt Transfers?
Exempt Transfers are those that are immediately free from Inheritance Tax, such as any Gifts from one spouse to another. Similarly, any Gifts and donations made to charities or political parties are also exempt from Inheritance Tax. Regardless of their value, there is no need to declare Exempt Transfers to HMRC.
On the other hand, a Potentially Exempt Transfer is a Gift of any value, gifted to any kind of individual that has the potential to become free from Inheritance Tax.
More specifically, the Gift must abide by the Potentially Exempt Transfer 7 year rule in order to be exempt from any taxes. In other words, the benefactor must live for an additional seven years after making the Gift to make the most of tax benefits.
What’s the difference between Potentially Exempt Transfers and Chargeable Lifetime Transfers?
So, what are Potentially Exempt Transfers in comparison to Chargeable Lifetime Transfers?
Potentially Exempt Transfers are only chargeable if the donor passes away within seven years of making the Gift.
Chargeable Transfers encompass all transfers that are instantly chargeable to Inheritance Tax. For example, any Gifts established into Trusts that surpass an individual’s nil-rate band are instantly subjected to a 20% IHT fee.
What’s a failed Potentially Exempt Transfer?
A failed PET occurs when the benefactor passes away within seven years of making the Gift.
When this situation arises, there will be a certain amount of Potentially Exempt Transfer IHT due to pay. How much IHT the PET incurs will depend on the value of the Gift and when the donor died.
Who pays tax on Potentially Exempt Transfers?
So, who pays Inheritance Tax on Potentially Exempt Transfers? If the value transferred surpasses the benefactor’s nil-rate band, the recipient of the Gift is liable for paying Inheritance Tax.
Do I have to declare a Potentially Exempt Transfer?
Yes, if the Potentially Exempt Transfer fails and Inheritance Tax is due, you’ll need to report this to HMRC.
How to declare a Potentially Exempt Transfer?
To declare a Potentially Exempt Transfer, you will need to fill in the IHT100 form located on the HMRC website.
Is a Gift a Potentially Exempt Transfer?
Any Gift has the potential to become an Exempt Transfer when you take into consideration the Potentially Exempt Transfer 7 year rule.
How much money can you Gift a family member tax-free?
It depends on your relationship with the family member and the circumstances. Generally speaking, you can make Gifts of up to £3,000 each year without having to pay any taxes.
Are Gifts to children for university fees Potentially Exempt Transfers?
Any transfers made towards your child’s maintenance expenses and education fees are not considered to be Gifts and, therefore, are free from Inheritance Tax.
Do I notify HMRC of a Potentially Exempt Transfer?
No, unless you come across a failed Potentially Exempt Transfer you are not required to notify HMRC of the Gift.
After exploring the potential of an Inheritance Tax Potentially Exempt Transfer, there is no denying that planning ahead is imperative. If you want to make the most of your financial opportunities, we recommend you start thinking about estate planning as soon as possible.
Navigating tax rules and regulations can be rather complicated, so it’s worth having some financial guidance along the way.
Making Gifts to loved ones earlier rather than later can help reduce the impact an Inheritance Tax Potentially Exempt Transfer poses on your estate and possibly result in thousands of pounds in savings.
If you still need advice regarding the use of an IHT Potentially Exempt Transfer, Efficient Portfolio works with a wealth of professionals who will be able to advise you further. Contact us today.