Taper Relief for Inheritance Tax purposes

Taper Relief for Inheritance Tax purposes

In brief

• Taper relief reduces the Inheritance Tax payable on a gift when the donor dies between three and seven years after making it.
• It reduces the tax and not the value of the gift.
• It only helps where the gift is larger than the nil-rate band available at the date of death.
• Gifts made more than seven years before death are outside the estate.

How the seven-year rule works

A gift to an individual is a potentially exempt transfer. If you live for seven years after making it, there is no Inheritance Tax to pay. If you die within seven years, the gift is added back and the tax is worked out at the rates in force at death. The standard rate is 40%.

The taper

Taper relief applies when death is three or more years after the gift. The tax is reduced on a sliding scale:

• 3 to 4 years: 80% of the tax is payable
• 4 to 5 years: 60%
• 5 to 6 years: 40%
• 6 to 7 years: 20%

For a gift made less than three years before death, the full rate applies.

What the relief does and does not do

The taper reduces the tax on the gift. It does not reduce the value of the gift for the purpose of using up the nil-rate band. The gift still uses the nil-rate band first. If a gift is within the nil-rate band of £325,000 there is no tax on it, so taper relief gives no benefit. The relief only matters on the part of a gift above the band. Gifts to a spouse, small gifts and regular gifts from surplus income are exempt, so the issue does not arise.

A worked example

Suppose a parent gives £525,000 to a child and dies five and a half years later. After the nil-rate band of £325,000 there is £200,000 of taxable gift. At 40% the tax is £80,000. Taper relief for between five and six years reduces the tax to 40% of that, which is £32,000. The child normally pays this tax, so the planning should consider how it will be met.

Why it matters in practice

Taper relief does not replace planning. Some families use life insurance to cover the potential tax for the first seven years. Others make gifts in stages so that each one is within the nil-rate band. Your will, the records of gifts and the list of beneficiaries should be reviewed regularly. Gifts also need to be genuine, as a gift with reservation of benefit remains in your estate. See our Inheritance Tax planning page.

Frequently asked questions

Does taper relief apply to gifts into trusts?

It can apply to chargeable lifetime transfers where death occurs within seven years, with its own calculation.

Who pays the tax on a failed gift?

Usually the person who received the gift, but the estate can be liable for part.

Do I need to keep records of gifts?

Yes. Keep a list of gifts for at least seven years.

If you would like to talk this through for your own situation, book a free call with our team.