Gift tax, as it’s commonly referred to, doesn’t exist in the UK in the same way it does in some other countries. However, understanding the implications of gifting large sums, like 1 million pounds, is crucial in the context of Inheritance Tax (IHT). Here’s what you need to know about how such a gift could be taxed under current UK law.
The Seven-Year Rule
In the UK, the tax implications for gifting large amounts of money are primarily governed by the seven-year rule. This rule applies to what’s known as ‘Potentially Exempt Transfers’ (PETs). When you gift money, this gift will be free of Inheritance Tax if you live for seven years after making the gift. If you pass away within these seven years, the gift may become taxable.
Taper Relief
If you give away 1 million pounds and die within seven years, the tax payable on the gift depends on how long you survive after making it. The tax rate on gifts is on a sliding scale, known as taper relief. It works like this:
- Less than 3 years: 40%
- 3 to 4 years: 32%
- 4 to 5 years: 24%
- 5 to 6 years: 16%
- 6 to 7 years: 8%
- More than 7 years: 0%
The Nil-Rate Band
Each person has a £325,000 nil-rate band for Inheritance Tax, which can also apply to gifts. If you haven’t used any part of this band, it can offset the amount of tax due. However, it’s applied to gifts first, before the rest of your estate.
Gift Tax on 1 Million Pounds: A Scenario
Imagine you gift 1 million pounds and die 4 years later. Assuming you haven’t used any of your nil-rate band, the first £325,000 of the gift is covered by this band. The remaining £675,000 is potentially taxable. Since the death occurred between 4 and 5 years after the gift, the rate is 24%. Therefore, the tax due would be 24% of £675,000, which is £162,000.
Other Considerations
Annual Exemption: Everyone has a £3,000 annual exemption for gifts. This can be carried forward one year if not used.
Gifts Out of Income: Regular gifts made out of your income, not affecting your standard of living, can be exempt from IHT.
Spousal Exemption: Gifts to spouses or civil partners are usually exempt from IHT, regardless of the amount or timing.
Charity Gifts: Gifts to charities are exempt from IHT.
Conclusion
Gifting significant sums, like 1 million pounds, can have substantial tax implications if not carefully planned. Understanding the nuances of Inheritance Tax law is vital. Professional advice tailored to your specific circumstances is recommended to navigate these complexities and optimize your tax position.