People are generally aware of the 7-year rule regarding lifetime gifts and how this can affect their ability to mitigate inheritance tax. However, fewer people are aware of the 14-year rule, known as the PET-trap. Here we discuss the 14-year rule and the consequences it can have on a person's inheritance liability.
What Is The 14-Year Rule?
Inheritance tax is a tax on the value of certain transfers made during a lifetime or upon death. Efficient tax planning can be used to reduce the liability of lifetime transfers, so usually, the main chunk of inheritance tax occurs on transfers made after the death of the donor.
Individuals can pass on their wealth tax free up to the value of £325,000. Assets that are worth more than this amount can result in an inheritance tax charge. Married couples and civil partners are entitled to double this allowance, the equivalent of £650,000. On top of this, there is also the "family home allowance" that will be worth an additional £175,000 per person by the end of 2021, equating to a total of £500,000 for individuals and £1 million for couples, with some deductions where the estate is over £2 million. Tax is charged at 20% in a lifetime and 40% on death once the nil-band rate has been exhausted.
Inheritance tax liability can be reduced by making gifts. There are three types of gifts:
- Exempt gifts- this includes any gift to a spouse or civil partner, gifts to charities and the annual £3000 exemption.
- Potentially Exempt Transfers (PET). These gifts fall outside of the estate’s valuation if they are made more than 7 years before the death of the donor. Gifts made within the 7-year period will incur inheritance tax, with taper relief between 3-7 years.
- Chargeable Lifetime Transfers (CLT). Which is the transfer of money or assets into a trust.
The general rule is that a person can make a gift as a PET and so long as they survive the 7-year period the value of the gift falls outside of the donor's estate for inheritance tax purposes. If they die within the 7-year timeframe, then the value of the gift will be added back into the value of the estate for inheritance tax purposes. PETs are usually gifts made between individuals and do not result in an immediate tax charge.
CLTs generally occur where a person transfers their assets into a trust during their lifetime. Lifetime inheritance tax will be payable on CLTs and to calculate this, it is necessary to look at the date of transfer (as opposed to the future date of death). The nil rate band at the date of transfer would be reduced by the number of chargeable transfers within the previous seven years (this is the CLT). So, the total value of any CLTs made within the last 7 years is calculated, and where this is above £325,000, there is an immediate inheritance tax charge of 20% (the lifetime rate for inheritance tax).
Where a person dies within 7 years of making either a CLT or PET, then there may be inheritance tax liability where the transfer exceeds the nil rate band, resulting in a 40% charge (this can be offset in some cases by any lifetime inheritance tax paid). Again, taper relief would be available, as discussed above.
Where someone makes a series of gifts, then each one is assessed against its own timeframe of 7-years to work out how much of the nil rate tax band it will use up. The 14-year PET-trap arises where a person's initial gift was a CLT and then makes another gift (a PET) then it will fall under the 14-year rule. This is where things become more complicated- the inheritance tax calculations will include any gifts that were made within seven years before a trust was established. This basically means that any gifts made up to 14 years before the donor's death could attract inheritance tax. What happens is any PET is reassessed and becomes part of the calculation in relation to inheritance tax together with any other taxable gift that the donor has made in the previous seven years before making the PET.
Since gifts are placed in the order that they are created, any CLT made in the seven years before a chargeable PET (i.e. a PET that was made in under 7 years from the donor's death) will use up the nil rate band first, which could result in an increase inheritance tax liability.
Chargeable transfers will have an effect on the available nil rate band for subsequent PETs for inheritance tax purposes where the donor dies within 7 years of making the PET and 14 years of creating the chargeable transfer. It is very important to take this into account where both CLTs and PETs are to be created. If you are considering making a PET where a CLT has already been created, it could be advisable to wait for the full 7 years to pass and/or to take out insurance to cover any tax liability that arises where a PET is made within 7 years of the CLT.
Contact Lewis Nedas Inheritance Tax Planning Solicitors, London
At Lewis Nedas, our specialist tax solicitors are regularly involved in helping clients organise their estate, to reduce its liability to pay inheritance tax. We provide a service that offers legal advice reflecting your needs. Our team understand and have vast experience navigating the complex and changeable legal framework concerning tax. We will work with you to make sure you understand how the tax laws will impact you, and discuss the options that would suit your particular circumstances. If you have any questions regarding estate planning or inheritance tax issues, please contact us.
For further information or to speak to our solicitors please telephone us on 020 3811 6784 or complete our online enquiry form.
