The use of exemptions in deferring and minimising inheritance tax liabilities

Welcome to Inheritance Tax (IHT) Exemptions!

Hello there! Today we are looking at one of the most practical parts of the ACCA Taxation (TX) syllabus: Inheritance Tax (IHT) Exemptions. Think of these as "tax-free coupons" provided by the government. If you know how to use them, you can help a client give away their wealth without the taxman taking a huge slice.

Don't worry if IHT feels a bit heavy at first. While it deals with some "grave" subjects, the rules for exemptions are actually quite logical once you see the patterns. Our goal today is to learn how to minimize or even eliminate tax liabilities using these tools.

1. The "Golden Rule" Exemptions: Spouses and Charities

The biggest exemptions in IHT are those that are 100% exempt. These apply whether the gift is made during someone's lifetime or through their Will when they pass away.

The Spouse/Civil Partner Exemption

Gifts between a husband and wife, or between civil partners, are generally completely exempt from IHT, provided both are domiciled in the UK.
Analogy: Think of a married couple as a single "bucket" of money. Moving money from one side of the bucket to the other doesn't change anything, so the taxman stays away!

The Charity Exemption

Any gift made to a registered charity is 100% exempt. This is the government's way of encouraging people to support good causes.

Quick Review: Transfers to spouses and charities = \( £0 \) Tax!

2. Lifetime Exemptions: Reducing the "Value" of Gifts

When a person makes a gift during their lifetime, we first determine the value of the gift and then subtract exemptions to find the "Chargeable Amount." Here are the tools in your toolkit:

A. The Annual Exemption (AE)

Every individual gets an Annual Exemption of £3,000 per tax year. This can be used against any lifetime gift.

• The Carry-Forward Rule: If you don't use your £3,000 in one year, you can carry it forward for one year only.
• The Order Rule: You must use the current year's exemption first. Only then can you use any leftover from the previous year.

Example: In 2023/24, Sarah made no gifts. In 2024/25, she gives her son £10,000.
Calculation:
Gift: £10,000
Less AE (2024/25): (£3,000)
Less AE (2023/24 carry forward): (£3,000)
Chargeable Amount: \( £4,000 \)

B. The Small Gifts Exemption

You can give up to £250 to as many different people as you like each tax year, and it will be completely ignored for IHT.
Crucial Note: You cannot combine this with the Annual Exemption for the same person. If you give someone £300, the "Small Gift" rule is broken, and you must use the Annual Exemption instead.

C. Gifts in Consideration of Marriage/Civil Partnership

If someone gets married, you can give them a tax-free wedding gift! The amount depends on your relationship to the couple:

• Parent: £5,000
• Grandparent (or great-grandparent): £2,500
• The Bride/Groom to each other: £2,500
• Anyone else (e.g., a friend or uncle): £1,000

Did you know? This exemption is per donor. If both parents give £5,000, that’s £10,000 exempt in total!

D. Normal Expenditure out of Income

This is a fantastic way to move a lot of money without tax. A gift is exempt if:
1. It is part of the typical/regular giving pattern of the donor.
2. It is made out of surplus income (not savings/capital).
3. The donor has enough money left over to maintain their normal standard of living.

Example: Paying a regular monthly life insurance premium for a child or a regular monthly allowance to a grandchild from your pension income.

3. Putting it into Practice: The Order of Calculation

When you are doing an IHT question, you must apply exemptions in a specific order to get the marks. Don't worry, just follow these steps:

Step-by-Step Gift Calculation:

1. Start with the Gross Value of the gift (the loss to the donor's estate).
2. Subtract the Marriage Exemption (if applicable).
3. Subtract the Annual Exemption (Current year first, then previous year).
4. The result is your Potentially Exempt Transfer (PET) or Chargeable Lifetime Transfer (CLT).

Common Mistake to Avoid: Students often forget that exemptions apply chronologically. If a client makes a gift in May and another in December, you must apply the Annual Exemption to the May gift first!

4. Why does this matter? (Deferring and Minimising)

By using these exemptions, we achieve two main goals:

• Minimising: Using the £3,000 AE and the £250 small gifts rule every year physically removes value from the estate so it is never taxed.
• Deferring: Making "Potentially Exempt Transfers" (PETs) allows a donor to give away unlimited amounts. If they live for 7 years after the gift, the gift becomes 100% exempt. We are "deferring" the tax check, and if the donor lives long enough, the tax becomes zero!

Key Takeaways for your Revision

- Spouses/Charities: Always 100% exempt.
- Annual Exemption: £3,000. Use current year first, carry back only one year.
- Marriage: £5k (Parents), £2.5k (Grandparents), £1k (Others).
- Small Gifts: £250 per person (cannot be mixed with AE for that person).
- Income Rule: Must be regular and from surplus income.

Encouragement: IHT can feel like a lot of numbers, but remember that these exemptions are the taxpayer's best friends. Master the "Marriage" and "Annual Exemption" rules, and you'll be well on your way to passing the TX exam!