Yahoo Finance The little-known inheritance tax loophole that has saved 400 families £70m
Families are shielding tens of millions of pounds from inheritance tax by using a little-known loophole.
Last year 430 families guarded £67m from death duties by using the “normal expenditure out of income exemption”, which allows individuals to make unlimited gifts completely free of IHT.
Many people choose to give away wealth during their lifetime in order to sidestep the divisive 40pc levy, which is ensnaring more and more families as property prices rise while tax thresholds are frozen.
It was recently revealed that the number of estates faced with an IHT charge hit a 20-year high of 41,000 in 2022, up from 33,000 the year before.
There are strict rules on how much can be gifted before IHT is due. One of the best known is the £3,000 annual exemption. Each individual can give away up to this amount every year IHT-free.
The “normal expenditure” rule allows families to gift far larger sums. But new figures from HM Revenue & Customs show that this potentially lucrative tax break is underused.
Over the past five years, just 2,490 taxpayers cut their IHT bills after claiming for the exemption, according to figures obtained by Telegraph Money in a Freedom of Information request. In total, they passed on £304m free from IHT.
In the last year just 430 families took advantage, but the combined saving was £67m.
Anyone with sufficient “surplus income” can use the tax break, meaning thousands more families may have neglected to claim, missing out on a huge IHT saving.
Sean McCann of the financial advice firm NFU Mutual said: “Gifts out of normal expenditure is one of the most powerful but least known exemptions. By allowing you to give away excess income immediately free from IHT, it can help stop your inheritance tax liability growing every month.
How can you use the normal expenditure exemption?
Under Section 21 of the Inheritance Tax Act 1984, taxpayers can give away sums of any size as long as they come under their “normal expenditure”.
To qualify, the payments should be in line with the donor’s general outgoings and ideally made on a regular basis. They must come out of the taxpayer’s income – this could be pensions, dividends, interest, rent or salary – without the donor having to compromise their living standards. So if after making the gifts the donor had to fall back on their savings to get by, HMRC would likely dismiss the claim.
As long as the gifts satisfy all three conditions, then they will be exempt from IHT.
The “normal expenditure” rule can also be used in conjunction with the £3,000 annual exemption, for an even bigger tax saving.
To make a claim, the family must fill in the IHT403 form, where they will have to note their late loved one’s income, expenditure and the gifts made out of surplus income. This is why good record-keeping is crucial if a donor plans to utilise the IHT loophole.
Official forecasts show that the number of families paying IHT is expected to rise to 47,000 per year by 2027-28 due to the freeze on tax thresholds.
This article was first published on May 3 2023, and is kept updated with the latest information.
