The IHT exemption that HMRC hides

Posted on 15th May 2024 by Joanne Stoneman

You have the task of obtaining probate for your mother’s estate which involves completing tricky inheritance (IHT) tax forms. One of these requires you to report lifetime gifts. How might the form’s wording cause you to miss out on an IHT exemption?

Lifetime gifts

You probably know that gifts made during your lifetime can affect the inheritance tax (IHT) payable on death. The rule is that gifts by one individual to another during the seven years before they die become liable to IHT.

Example. Harry died on 1 May 2024 aged 70 leaving his whole estate to his two children. He has never been married or in a civil partnership. His net estate is worth £490,000. The estate consists of his home, valued at £390,000, plus £100,000 of investments. He also has an unused registered pension fund of £600,000 but, as is usually the case, it doesn’t count as part of his estate.

The IHT 0% rate applies to the first £500,000 of Harry’s estate: £325,000 nil rate band (NRB) plus £175,000 residence nil rate band (RNRB) because he owned a home which passes to a direct descendant. It might seem therefore that there’s no IHT to pay, but unfortunately that’s not the full picture. Prior to his death Harry made gifts to each of his two children. These totalled £63,000 spread over four years. After deducting his annual IHT exemption (£3,000) for each of the years, the remaining £51,000 is knocked off his NRB reducing it to £274,000. Therefore, only £449,000 (£274,000 + £175,000) of Harry’s estate is taxable at 0%. The remaining £41,000 is taxable at 40%.

Detective work

Completing IHT forms requires executors to trawl through the deceased’s financial records, e.g. bank statements, for at least the seven years leading up to their death to look for gifts. These must be reported on the IHT forms, specifically IHT403.

Make your executor’s work a lot less arduous by keeping a separate record of gifts you make. Keep this with your financial records and after each tax year attach an updated copy with your will.

No IHT on exempt gifts

The “normal expenditure out of income” exemption can apply to cash gifts, no matter their value. 

Example. The gifts Harry made to his sons totalled £20,000, £3,000, £3,000 and £27,000 respectively for the four years. To count as “normal expenditure”, and therefore exempt from IHT, the gifts must, taking one year with another, form a pattern, e.g. made every tax year or at least every other tax year. Despite the varying amounts, Harry’s gifts meet the condition.

HMRC’s misdirection

If Harry’s executor reports all the gifts on the IHT403 he would easily spot the pattern of gifts and claim the exemption. The trouble is HMRC’s guidance on the form says “Do not tell us about any gifts where the total value was £3,000 or less in any tax year, small amounts of £250 or less...” . If the executor followed this advice and ignored each of the £3,000 gifts the terms of the “normal expenditure” exemption would apparently not be met. This might cause an inexperienced executor not to claim the exemption which would result in HMRC demanding IHT that it wasn’t entitled to. We recommend taking professional advice if you’re not sure about completing the IHT forms.