Gifts out of surplus income exemption

The ‘gifts out of surplus income’ exemption is a powerful, yet often forgotten about, Inheritance Tax (IHT) exemption. As the name suggests lifetime gifts made from surplus income are immediately exempt from IHT, provided that certain conditions are met.

To qualify for this valuable relief, the following conditions need to be satisfied:

• The gifts need to form part of the donor’s normal expenditure; and
• Must be made from surplus income (not capital); and
• Does not affect the donor’s standard of living.

The value of such gifts which meet the above conditions will immediately fall out of your estate for IHT purposes and will not be on the ‘7-year clock’.

What is ‘normal’ expenditure?

The dictionary definition of ‘normal’ is typical, regular, or habitual expenditure for the donor. The gifts should be made on a regular basis or follow a pattern, i.e., monthly, quarterly, or annually, the amounts gifted do not necessarily need to be the same, but gifting should be comparable year on year.

What is ‘surplus income’?

As the name implies, surplus income is the income that you have left over or is in excess of, all of your usual regular outgoings and expenses have been accounted for, such as bills and other expenses. If you regularly have excess income left over after meeting your expenditure, rather than investing it or placing it in savings, this surplus income can be used to fund gifts instead.

The benefit of the exemption is that there is no specified monetary limit to the exemption because income and normal expenditure, as well as the other criteria can vary so much from person to person.

It must be stressed that you will not qualify for the relief if you are making gifts but must rely on capital to fund essential living expenditure and to maintain your standard of living.

Useful tips to bear in mind.

• Your income is comprised of all income, including non-taxable income such as ISA interest and/or dividends and some benefits in addition to premium bond winnings.

• It is important to keep records of your income and expenditure, in case HMRC raise a future enquiry or compliance check. It is recommended to summarise your annual income and expenditure on a form IHT 403, which enables you to analyse your annual income and expenditure into categories and thereby calculate and determine your surplus income position each tax year. Where you are required to prepare, complete and submit an annual self-assessment personal tax return, it is recommended for this exercise to be completed alongside your return.

• Keep a record of income and expenditure for 2 – 3 years prior to your first gift. This is because HMRC will usually accept that unused income is ‘accumulated’ to capital after 2 – 3 years.

If you would like any further information on this valuable IHT exemption or any other IHT or capital taxes planning options, factoring into your personal circumstances, please do not hesitate to get in touch with your local Whitings Office.

Disclaimer - All information in this post was correct at time of writing.