Understanding Taper Relief
When it comes to inheritance tax (IHT), many people are aware that gifts made during their lifetime can reduce the value of their estate. However, not all gifts are treated equally, and understanding how taper relief works on Potentially Exempt Transfers (PETs) can help with effective estate planning. Let’s break it down simply.
What is a Potentially Exempt Transfer (PET)?
A PET is a gift made to an individual (or certain trusts) that is free from IHT at the time it is given. However, for it to remain completely tax-free, the giver (the donor) must survive for seven years after making the gift. If they pass away within this period, the PET becomes taxable as part of their estate.
When Does Taper Relief Apply?
Taper relief applies if a PET becomes taxable because the donor dies within seven years, but only if the total value of chargeable gifts exceeds the available nil rate band (NRB), which is currently £325,000. Importantly, taper relief does not reduce the amount of the gift itself - it only reduces the tax due on the excess over the NRB.
Put another way, if the gift falls within the donor's available nil rate band at the time it is made (taking previous gifts into account), then there's no tax due. No tax due means no taper relief is available.
Example 1: No Taper Relief Needed
Sarah gifts £200,000 to her son. This is a PET. She lives for six years before passing away. Since this gift is within her £325,000 nil rate band, no IHT is due on the gift, and taper relief is irrelevant. However, until 7 years have elapsed since making the gift, it will reduce the amount of nil rate band available when working out the tax due on Sarah's estate.
Example 2: Taper Relief in Action
John gifts £500,000 to his daughter. He passes away just over five years later. The first £325,000 of his gift is covered by his nil rate band, leaving £175,000 exposed to IHT.
Without taper relief, this excess would be taxed at 40%, resulting in £70,000 of tax. However, because John survived for between five and six years, the tax due is reduced by 60% under the taper relief rules. This means the actual IHT payable is £28,000 instead of £70,000.
Taper Relief Scale
The taper relief scale is as follows, based on the number of years that have elapsed since the gift was made to the date of death.
Less than 3 years: No reduction (40% tax rate applies)
3 to 4 years: 20% reduction (tax rate effectively 32%)
4 to 5 years: 40% reduction (tax rate effectively 24%)
5 to 6 years: 60% reduction (tax rate effectively 16%)
6 to 7 years: 80% reduction (tax rate effectively 8%)
After 7 years, the gift is completely free of IHT.
What about Exemptions?
If you're thinking of making gifts, you might also find our other article helpful which explains about the IHT Annual Exemption. You can read it here: https://www.spendtimefp.com/post/now-s-a-great-time-to-gift
Key Points
PETs are IHT-free if the donor survives for 7 years.
If the donor dies within 7 years, gifts within the nil rate band remain tax-free.
Taper relief only applies to the tax due, not the value of the gift. No tax, no taper.
The longer the donor survives beyond three years, the less tax is payable on the excess over the nil rate band.
Understanding these rules can help you make informed decisions about lifetime gifting and estate planning. If you’re considering making substantial gifts, professional advice can ensure you do so tax-efficiently.
Best wishes,
Michael Roberts FPFS
Chartered Financial Planner and Director
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