Taxpayers are being urged by HM Revenue & Customs (HMRC) to adopt a straightforward administrative habit that could prevent an unexpected 40% inheritance tax charge. The warning follows a specific enquiry from an individual seeking clarity on the rules for making substantial cash gifts.
The £400 pitfall in poor record-keeping
A taxpayer recently contacted HMRC for guidance, outlining a scenario where they wished to make a large cash gift to their child. The sum was below the £325,000 nil-rate band, and they had not exceeded this threshold in gifts over the previous seven tax years. Believing the gift would be entirely tax-free, their central question was: "Do I still have to inform HMRC at the time of the donation?"
In response, HMRC confirmed that while there is no legal requirement to notify them immediately when making such a gift, it is critically important to keep accurate, contemporaneous records. This is so the executors of your estate can correctly report it after your death.
Failure to maintain proof could mean a gift intended to be tax-free is incorrectly included in the value of your estate. For example, if you gave £1,000 to a relative but left no clear record, your heirs might be forced to pay an additional £400 in inheritance tax on that amount.
Understanding your annual gifting allowances
Beyond the seven-year rule, there are several annual allowances that let you reduce your estate's value without any immediate tax implications. Utilising these can be a key part of inheritance tax planning.
- Annual Exemption: You can give away up to £3,000 each tax year, split between any number of people. Any unused allowance can be carried forward one year.
- Small Gift Allowance: You can make gifts of up to £250 to any number of individuals, provided you haven't used another allowance for the same person.
- Wedding or Civil Partnership Gifts: Parents can gift £5,000 to a child, grandparents can give £2,500, and anyone else can gift £1,000 tax-free for these occasions.
Key inheritance tax thresholds and reliefs
The core nil-rate band, the amount you can pass on free of inheritance tax, currently stands at £325,000 per person. Crucially, there is an additional residence nil-rate band of £175,000 if you leave your main home to direct descendants like children or grandchildren.
This means an individual could potentially pass on £500,000 tax-free. Furthermore, any unused portions of these allowances can be transferred to a surviving spouse or civil partner. This could allow a couple to pass on a combined estate worth up to £1 million without incurring inheritance tax, provided it includes a main residence passed to direct descendants.
The central message from HMRC remains clear: while the system allows for significant tax-free gifting, the burden of proof lies with the estate. Meticulous record-keeping is not just sensible; it is a financial safeguard that ensures your generosity benefits your loved ones as intended, not the taxman.
