When most people think of inheritance tax, the first thing that comes to mind is the tax paid on the estate left by somebody who dies. This of course, is the most common example of inheritance tax, however there may also be inheritance tax to pay on the gifts that a person made while they were alive.
An important concept to understand regarding lifetime gifts is the 7 year rule. This rule states that if a person makes a gift and then lives on for 7 years afterwards, there is NO inheritance tax to be paid on this gift. However if the person dies before the 7 years has passed there is inheritance tax to be paid but this may be paid a reduced rate: this relief is known as taper relief.
How is Taper Relief Applied?
In theory the application of taper relief is fairly simple. You take the amount of the gift subject to inheritance tax and calculate the number of years between the date of the gift and the date of the gift,.
Using this information we can work out the reduced amount of Inheritance tax due based on the table below
| Years between gift and death | Tax paid |
|---|---|
| less than 3 | 40% |
| 3 to 4 | 32% |
| 4 to 5 | 24% |
| 5 to 6 | 16% |
| 6 to 7 | 8% |
| 7 or more | 0% |
Example
Let’s take an example of somebody leaving a gift to their friend of £100,000 in cash. They leave this gift in April 2015 and subsequently die in May 2020.
The first step required to calculate the inheritance tax due on this gift is to work out the time between the date of the gift and the date of death:
- April 15 to May 20 is 5 years and 1 month and thus the amount of taper relief required will fall into the 5 to 6 year relief bracket
- This means instead of paying 40% inheritance tax, only 16% will be paid .
For our calculation, we will assume that the £325,000 nil rate band was already used up and therefore, inheritance tax is due on the full amount of the gift which is £100,000.
- From here we simply take 16% of £100,000 and this is the amount of inheritance tax due.
- £100,000 * 0.16 = £16,000
Now, after all the calculations have been done we can see that the amount of inheritance tax due on the gift adjusted for taper relief is £16,000. This is a significant reduction on the original amount which would have been £40,000.
Summary
The main principle to keep in mind when looking at taper relief is that the longer it is between the time a person makes a gift and a person dies, the lower the amount of inheritance tax due will be.
Remember, if a person dies 7 years after making a gift, there is NO inheritance tax to pay.