The thresholds first
Inheritance tax is charged at 40% on the part of an estate above the £325,000 nil rate band. If you leave 10% or more of the net estate to charity, the rate on the rest drops to 36%.
If you leave your home to children or grandchildren, the residence nil rate band can lift your threshold to £500,000. And any unused threshold passes to a surviving spouse or civil partner, which is how a couple can reach £1m between them.
There is no inheritance tax on anything you leave to a spouse or civil partner, or to a charity.
The gift allowances people never use
These are genuinely useful and widely ignored.
Annual exemption: £3,000 a year, given to one person or split between several. You can carry an unused annual exemption forward, but only one year. So a couple who have used nothing can move £12,000 out of their estates immediately.
Small gifts: £250 per person, to as many people as you like, each year. You cannot combine it with another allowance for the same person.
Wedding gifts: £5,000 to a child, £2,500 to a grandchild or great grandchild, £1,000 to anyone else. These can be combined with the annual exemption, so a child marrying can receive £8,000 free of inheritance tax from each parent.
Normal expenditure out of income: this is the powerful one and almost nobody uses it. There is no limit, provided the gifts are made from surplus income rather than capital, are part of a regular pattern, and leave you able to maintain your usual standard of living. Paying a grandchild school fees or a child rent can fall within it.
The catch with that last one is records. The executor has to prove the pattern and the income surplus after you are gone. Keep a simple annual note of income, expenditure and gifts. Without it the exemption is very hard to claim.
The 7 year rule, and the taper myth
Give something away and live 7 years, and it is outside your estate entirely.
Die within 7 years and the gift may be taxed on a sliding scale. Gifts in the 3 years before death are taxed at the full 40%. After that, taper relief reduces the rate: 32% at 3 to 4 years, 24% at 4 to 5, 16% at 5 to 6, 8% at 6 to 7, and nothing after 7.
Now the part almost every article gets wrong. Taper relief only reduces tax that is actually payable on a gift. If a gift falls within the nil rate band once earlier gifts are added in, there is no tax attributable to it, so there is nothing to taper. Below the band, taper does nothing at all.
Two refinements that most guides miss. The threshold is your nil rate band, not a flat £325,000. If your personal representatives can claim a late spouse unused band, the threshold on your death could be £650,000, and gifts that would otherwise have been tapered may fall below it entirely, in which case no taper arises. And the test cumulates: each gift is measured against the band after adding gifts made in the 7 years before that gift, so an older gift can push a later one over the line.
Also note that taper reduces the tax, not the value of the gift, and only on the slice above the band. Applying 32% to the whole gift, which is the instinctive reading of the table above, will give you the wrong answer.
So the common belief that a £50,000 gift given 4 years before death is somehow taxed at 24% is simply wrong. It is within the nil rate band, so there is no tax on it at all. Taper relief reduces tax that is actually payable. It does not create a discount on gifts that were never taxable.
Note too that gifts eat the nil rate band first, in order, which can push more of the remaining estate into charge.
Giving something away but still using it
If you give something away and continue to benefit from it, it is a gift with reservation and it stays in your estate regardless of the 7 years.
The classic is signing the house over to the children and carrying on living in it. That does not work. It has never worked. It is also worth knowing that the family home given away this way loses its capital gains exemption for the children and may create a stamp duty problem, so the failed inheritance tax plan often costs more than it saves.
Common questions
Do I have to tell HMRC when I make a gift?
No, but keep a record: what, to whom, how much and when. Your executor will need it, and reconstructing 7 years of gifts after a death is miserable.
Who pays the tax on a gift?
Usually the estate. But if you gave away more than £325,000 in the 7 years before death, the recipients of those gifts can become liable for the tax on theirs.
These figures and the taper rates are taken from current HMRC guidance. Inheritance tax planning interacts with wills, trusts and capital gains, so it is worth proper advice rather than a web page. Get in touch.