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What is Inheritance Tax and Taper Relief?

Inheritance Tax (IHT) is a tax that is becoming more prevalent each year for more and more people as house prices, in particular, rise whilst the IHT threshold remains at the 2009 level of £325,000.00.

I am personally of the view that the Conservative Party will announce some form of significant increase of the IHT threshold as part of its manifesto for the 2015 election but, in the meantime, it is always worth considering practical planning steps that can be taken to reduce your IHT liability in order to preserve your family wealth for future generations.

However, one part of inheritance tax planning, in my experience, is poorly understood and can lead clients to take the wrong decision when planning in respect of their own IHT liability. This issue is taper relief in respect of Inheritance tax.

As most people are aware you can make a gift for IHT purposes and after 7 years, that gift is considered tax free for IHT purposes.  Taper relief is available to reduce the IHT payable by 20% after 3 years and a further 20% for each successive year until 7 years.

Thus, for example, if a gift of £500,000.00 has been made, there is a potential tax liability of £200,000.00 payable (40% of £500,000.00). As such, many people believe that if the donor died 5 years and 1 month following the gift they would be entitled to taper relief of 60% of the original gift, i.e. reducing the tax payable on the gift to £80,000.00 (a tax saving of £120,000.00).

However, taper relief is not applicable to that part of a gift which relates to the nil rate band (currently £325,000.00). Thus, assuming in the example above that the donor had made no other gifts, the actual taper relief would only  relate to that part of the gift over and above the nil rate band i.e. £175,000.00. Thus the taper relief available in the example would be 40% x £175,000.00 = £70,000.00 x 60% taper relief meaning a tax saving of £42,000.00.

Obviously, every case will be different but feel free to contact me directly with any questions that you have regarding your IHT liability.

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