Patrick Connolly of Chase de Vere helps a reader with a question about inheritance tax.
I read with interest the Essential Guide to Inheritance Tax by Ceri Jones, as I have been looking into IHT planning. A point that was not mentioned was the 14-year rule, which I stumbled across in my research and might have been worth mentioning in the section about setting up a trust.
Barrie Culley, by email
Patrick Connolly of Chase de Vere replies: Inheritance tax is payable on transfers in excess of the nil rate band (NRB), which is currently £325,000. It is a cumulative tax and applies to transfers made during your lifetime and on death. If you make a transfer during your lifetime, it is either exempt from inheritance tax, a potentially exempt transfer (PET) or a chargeable lifetime transfer (CLT).
The most common CLTs are lifetime gifts to trusts, other than bare trusts or trusts for disabled people. There is an immediate tax charge if you make a CLT that takes the seven-year cumulation of these transfers over the nil rate band. Tax is payable at 20% on the excess over the NRB.
There is no tax to pay on a CLT or a PET that is made more than seven years before the death of the donor. However, a CLT made more than seven years before death can affect the amount of tax payable on a subsequent CLT or a failed PET – the ‘14-year rule’.
Any CLTs made in the seven years before a subsequent CLT, or a failed PET which then becomes a CLT, will reduce the available NRB for the transfer being assessed and so potentially increase the tax payable on it.
As an example, if someone made a gift of £200,000 into a discretionary trust on 1 November 2009 there would have been no inheritance tax payable at the time as the CLT was less than the NRB. She then made a PET of £200,000 on 1 October 2016. She died on 1 September 2019 and there was no transferable or residence NRB. There is no tax payable on the CLT made in 2009, as this was made more than seven years before death. The PET from 2016 failed, as death occurred within seven years, and so it becomes a CLT and is chargeable. The original CLT from 2009 was made within seven years of the next CLT, the failed PET from 2016, and so it will reduce the NRB available for it from £325,000 to £125,000.
The inheritance tax payable on the PET will therefore be (£200,000 failed PET value minus £125,000 remaining NRB) x 40% = £30,000. If the person had waited another month until 1 November 2016 to make the PET, which is seven years after the original CLT, it would have benefited from the full nil rate band and saved an inheritance tax bill of £30,000.
This is a very complicated area, and if you’re not sure what you are doing then you should take independent financial advice.
If you need help with a tax, pension or financial planning problem, please email: firstname.lastname@example.org
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