People often worry that they may need to pay tax if they give or receive money from friends and family. This is not helped by some online guides which focus on ‘exemptions’ from tax, implying that amounts over the exemptions must involve tax.
Here’s the good news: almost nobody in the UK will need to pay tax on a gift they receive from (or give to) another person, regardless of the amount.
Do I pay Tax on Gifts I Receive?
You do not need to pay income or capital gains tax on gifts that you receive. Gifts are not classed as income or capital gains.
Ordinarily you should not expect to pay Inheritance Tax (IHT) on a gift either.
There is an incredibly rare circumstance where you, as a recipient of a gift may need to pay inheritance tax.
This could only happen if the person who gave you the gift subsequently dies within 7 years, and had given away more than the Inheritance Tax allowance (currently £325,000) in those 7 years, and their estate owed Inheritance Tax without sufficient money left in the estate to pay it.
In some exceptionally rare cases, the “clock” may go back 14 years. See the “Limitations and Edge-cases” section at the end of this page for more information.
How Inheritance Tax works
Inheritance tax allowances
For the majority of people, no Inheritance Tax is due on their estate when they die. This is because every person has an Inheritance Tax ‘Nil-rate band’ of £325,000 (they can leave £325,000 tax-free) and an additional ‘Residence Nil-rate Band’ of £175,000 (tax-free amount when leaving their primary residence to their children or grandchildren). The Residence Nil-rate Band is removed progressively on estates between £2M and £2.35M in value.
Inheritance between spouses is tax-free, and spouses inherit each other’s unused nil-rate bands. This means that a married or civil partnered couple effectively have £650,000 tax-free allowance between them, with up to a further £350,000 specifically for leaving their house to their children or grandchildren.
If the deceased person has an estate valued at under these allowances, it is unlikely that any IHT would ever fall due.
If an estate’s value exceeds the tax-free (nil-rate) allowances, IHT is paid on the amount above the allowances.
The 7 year rule for gifts
To prevent people from signing away their money and assets last minute to dodge Inheritance Tax, gifts given within the last seven years of someone’s life are treated as part of their estate.
On death, the value of the deceased person’s property, money and possessions plus the gifts given in the seven years before death are added together to calculate the total value of the estate for IHT purposes. This is the number that is compared to the tax-free allowances described above.
The nil-rate band is used up by gifts in the order they were given. Therefore, no IHT falls due on gifts if the total of gifts given in the previous seven years is less than £325,000. The Residence Nil-Rate Band cannot be used against gifts given in somebody’s lifetime.
If IHT is due on the gifts (because they totalled more than £325,000), the recipient may be liable, and has an obligation to report the gift to HMRC. If you receive a large gift from somebody (in the hundreds of thousands), you should keep a record of this just in case.
It’s important to understand that even when gifts do end up included in this total, and potentially cause the estate to exceed the tax-free allowance, the amount of tax owed would be no worse than if the giftor had died without making these gifts. In fact, the tax bill would usually be lower, due to the exemptions described below.
Exemptions for gifts
Not all gifts given in the 7 years before death are included in the total value of the estate. There are exemptions, the best known of which is the ‘annual exemption’ of £3,000 – each year you can gift up to £3,000 to one person, and that gift will not be counted towards the value of your estate on your death.
There are other exemptions too. The main ones are:
- ‘small gifts’ (gifts totalling under £250 per person)
- wedding gifts
- maintenance payments to support the living costs of a child (under 18) or disabled relative
- regular payments out of income with no impact on quality of living.
Remember that these ‘exemptions’ are not limits on what can be given “tax-free”. Rather that gifts beyond these exemptions could count as part of a deceased person’s estate, for the purposes of calculating whether (and if so how much) IHT is due.
Paying Inheritance Tax
If the total value of the estate exceeds the allowances described above, Inheritance Tax will be due on the amounts exceeding the allowances. The standard rate is 40%.
For example, if an estate is worth £500,000, then the Inheritance Tax charged would be £70,000 (40% of £175,000). This would be paid to HMRC by the estate before the remaining money is distributed to inheritors.
In a hypothetical example where the £500,000 value of the estate was made up almost entirely of gifts given in the last few years of their life, and the deceased died with less than £70,000 in savings and possessions, the recipient(s) of those gifts might need to pay the tax bill.
Because of a lack of understanding over these rules, people often make mistakes that can cause problems later on. This list is by no means exhaustive:
- Not giving gifts at all for fear of tax (when it’s almost always better from a tax perspective to give gifts while you’re still alive)
- Structuring gifts as “loans” because they think this avoids the tax issues (it actually makes things worse, as these loans are typically forgiven by the estate, and count as a gift on the day of death, rather than earlier when they could have become exempt from the tax)
- Giving big gifts away whilst relatively young, but retaining use of them. This most often relates to people giving away ownership of the house they continue to live in. If they don’t truly give the benefit of the gift away (by moving out so the giftee can live there or rent it out, or paying their giftees a market rent themselves), it is known as a gift with reservation and causes all sorts of problems.
Inheritance Tax planning can be a complex area and one where it is potentially worth getting professional advice.
Sally died in September 2022, leaving £500,000 in savings equally to her four grandchildren. She was not married or in a civil partnership, and didn’t own a property.
- Ten years before her death she gave £25,000 to each of four grandchildren.
- There is no inheritance tax to pay on this as the money was given more than 7 years before she died.
- Five years before her death, she again gave all four grandchildren £25,000.
- She uses the annual exemption (£3,000) twice (you can claim for one previous year). The amount assessable for IHT is £94,000.
- Four years before her death, she again gave all four grandchildren £25,000. One grandchild was getting married.
- She uses the £3000 annual exemption, and claims the marriage exemption (£2,500) for the grandchild who is getting married. IHT assessable: £94,500
In this case, the total of IHT-assessable gifts in the seven years prior to death is £188,500. The nil-rate band of £325,000 is set against this amount, and no tax is due on the gifts.
For the £500,000 estate, there is £136,500 nil-rate band remaining, so IHT of 40% is due on the remaining £363,500. This comes to £145,400.
If the gifts hadn’t been given, the estate would be worth £800,000, and the £325,000 nil-rate band would be set against that, with a tax bill of £190,000.
Doesn’t the ‘seven year rule’ reduce the values of gifts?
Taper relief is applied to tax due on gifts made more than 3 years prior to death – the rate of tax owed reduces with each year.
It is not applied to gifts given within the nil-rate band.
What counts as a gift?
A gift for Inheritance Tax purposes is any transfer of value where there isn’t equal compensation.
This means that things like sums of money and items gifted outright are included, but it also means that “bad bargains”, where somebody receives less than the market value for something, could also be captured.
An example would be a parent selling their house to their children for half the market value. The other half of market value that the child didn’t pay for would be considered a gift. Another less obvious example would be forgiving a past loan.
Limitations and edge cases
This article is UK specific, and we make the assumption that all parties are domiciled in the UK. If this is not the case the situation may be quite different.
Capital Gains Tax
Gifting an asset that has appreciated in value will crystallise its capital gains at market value, and may result in a Capital Gains Tax bill for the person making the gift.
Chargeable Lifetime Transfers
This article only discusses gifts from one person to another, which is known as a “Potentially Exempt Transfer”. Another type of gift is called a Chargeable Lifetime Transfer. They are usually gifts to a discretionary trust or Family Investment Company. These are transfers which are not potentially exempt.
They have a different set of rules, and most people won’t come across them except under advice from a tax professional. If you are interested, you can read more in HMRC’s IHT Manual.
Very occasionally, 7 is 14
There is a very rare occasion where the “7 year rule” could look back up to 14 years. This would only happen if a sizeable Chargeable Lifetime Transfer was given 7 years before a ‘failed Potentially exempt transfer’, and could really only happen as part of a gifting strategy under tax advice from a professional. An article on this topic can be found here.