There is much confusion over the topic of taper relief. We often hear people repeat the same misunderstandings over how taper relief works, which isn’t surprising given the press repeatedly get it wrong themselves. So, we thought we would do a short blog setting out how and when taper relief applies.
7-Year Rule
When you make gifts to family, in most cases you must survive 7 years and a day for them not to be assessable to Inheritance Tax (IHT). If you survive this period, the gifts become exempt and are not subject to tax. The main rate if IHT is 40%.
As such, these gifts are technically referred to as “Potentially Exempt Transfers” – they are then either exempt or chargeable depending on whether or not you survive more than 7 years.
There are a number of gifts which are immediately exempt and not subject to the 7-year rule, the most common of which are:
- Transfers between spouses
- Charitable gifts
- Amounts within an annual exemption of £3,000 (you can carry forwards the previous tax year’s allowance if unused)
- Regular gifts out of surplus income
Taper Relief
The common misconception is that the value of these gifts for tax purposes is gradually reduced between 3 years and 7 years after the date of the gift as follows:
| Years Since Gift | Taper Relief |
| 0-3 | 0% |
| >3 | 20% |
| >4 | 40% |
| >5 | 60% |
| >6 | 80% |
| >7 | 100% |
Taper Relief does apply at the rate above, but crucially it only applies to any tax liability, not the value of the gift. This may seem like a small technicality, but this subtle difference means Taper Relief does not apply to the vast majority of gifts made.
The Nil Rate Band
The reason for this is the Nil Rate Band. This is the amount – currently £325,000– that someone can pass on without paying IHT. On death, the Nil Rate Band is first set against any (non-exempt) gifts in the past 7 years. Any remainder is then available for distributions from the estate.
So, for example, if someone gifted £100,000* less than 7 years before death, this would use up £100,000 of their Nil Rate Band. The remaining £225,000 would then be available for their estate.
It doesn’t matter if the individual died the day after the gift or 6 years later – it will still use the Nil Rate Band. There is no tax liability associated with the gift either way, therefore no tax for Taper Relief to apply to. In either case the gift has consumed £100,000 of the Nil Rate Band and no IHT reduction has been achieved.
Gifts within the Nil Rate Band do not benefit from Taper Relief. Cumulative gifts within 7 years, must exceed the Nil Rate Band for Taper Relief to apply.
In another example, if someone gifted £500,000* less than 7 years before death, the first £325,000 of the gift would consume the Nil Rate Band, but the £175,000 could benefit from Taper Relief, if the donor survived more than 3 years and a day from the gift.
* ignoring the annual exemptions / assuming these are already used.
Misconception vs Reality – Examples
Below is an example of how Taper Relief would apply to gifts of £100,000 and £500,000 (again, assuming all £3,000 annual exemptions are already used), comparing reality to how it is often portrayed:
The first, £100k gift example shows how no tax saving is achieved on gifts below the Nil Rate Band until 7 years. This is because Nil Rate Band is simply used, which would otherwise reduce the value of the taxable estate and no taper relief is received on the gift as there is no tax liability attached to it.
The £500k gift scenario shows how taper relief gradually applies to the gift in excess of the Nil Rate Band. The majority of the tax saving is still not achieved until after surviving 7 years, when the gift becomes exempt and no longer consumes the Nil Rate Band.
Gifts into Trust
This blog has discussed gifts to individuals. Gifts into most trusts (those where the trust is a separate legal entity and the trustees retain control over distributions) are different – such gifts are immediately chargeable to IHT at outset (known as “Chargeable Lifetime Transfers”). A lifetime IHT rate of 20% (half the main rate) applies – if death occurs within 7 years, the remaining 20% is charged on the value of the gift.
Again however, you can set the £325k Nil Rate Band against such cumulative transfers within the past 7 years, to avoid any immediate charges to IHT. Because of this, most gifts into such trusts are limited to £325k. On death within 7 years, Taper Relief would apply to any tax liability associated with the transfers. For gifts into trust over £325k which incur tax at outset, Taper Relief can only reduce the additional tax payable in death, it can’t lead to a refund of the lifetime charge at outset.
Concluding Comments
There are many reasons to make gifts, saving Inheritance Tax is just one of them. Furthermore, in most cases gifting assets (both to trusts and individuals) will be the most significant part of estate planning undertaken.
The fact that Taper Relief doesn’t apply in most cases doesn’t change either of these facts. If anything, it just necessitates that gifting plans are considered in good time, keeping in mind the full 7-year time frame.
If you would like to discuss and review your estate plans and gifting strategies, please use the button below to book a meeting.
Disclaimer
The above is provided for general information only. No action should be taken without seeking advice for your specific circumstances. Collingbourne Wealth Management Ltd does not provide tax advice. All information is based on our understanding of current tax rules as at the time of writing, which are subject to change.