Everyone loves a festive gift of money, including the taxman

Nothing simpler than giving cash, right? Wrong, writes John McArthur

‘TIS the season to be jolly, as the old saying goes; it is also better to give than to receive. Combine the two and the afterglow of Christmas may carry you through the dark cold days of January.

But while Christmas is a popular time for giving money to your children or other family members, don’t forget there are limits on how generous you can be with your cash gifts before the taxman begins to take an interest.

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Governments of all political parties have been rather ungenerous over the years about the amounts that can be gifted free of all inheritance tax (IHT) concerns. They have not raised the threshold since at least 1984. Some would argue it is about time that they did, but in the meantime the following gifts can be made free from IHT:

n Small gifts of up to £250 per person per year. This is designed to cover birthday and Christmas gifts, but is now not enough to cover many electronic gadgets.

n Gifts above £250 but totaling less than £3,000 in any year. This is the exemption that applies to the total amount that can be gifted each year beyond the small gift exemption. If any part of this exemption is unused in one year it can be carried forward to the next year. If it is not then used it is lost. In other words, the maximum that can be gifted free of IHT in any two-year period is £6,000 per person, so married couples and civil partners can gift £12,000 between them in one year and from then on £6,000 each year. If one spouse cannot afford to make the maximum tax-free gift there is nothing to prevent the other spouse transferring funds to allow the maximum gift to be made.

n Annual gifts of excess income – the normal expenditure out of income exemption can be made completely free of IHT. If your annual income is, say, £60,000, but you are only spending £40,000, you can gift the balance free of IHT. An example of this situation could be when someone is in a care home; the annual fee (£40,000) is known and the person’s income (£60,000) leaves an excess. HM Revenue and Customs (HMRC) has just tightened the rules concerning this exemption but provided there has been a history of such gifts or an intention to continue making them, these gifts will be IHT free. Careful records must be kept in order to justify a claim and you will have to show that when these gifts were made you did not reduce your standard of living or have to sell some investments to maintain your standard of living. It is safer to take specialist advice about using this allowance as record keeping is vital to save costs later.

• Gifts to qualifying charities of any amount are IHT free. Do not forget to use gift aid if you can because the charity can recover the income tax you have paid on any income earned equivalent to the value of the gift.

• Gifts of £5,000 (from each parent), £2,500 (from each grandparent) and £1,000 (from everyone else) are tax free if given “in consideration of marriage”. To qualify the gifts must be made before the marriage.

• Parents and grandparents can now contribute money to a junior Isa, after the accounts were launched on 1 November (although not all banks have made products available yet). The money is locked away until the child is 18 and with a careful choice of fund manager and an eye on the fee structure and performance of the investments hopefully a significant nest egg will be available for them when they become an adult. Such investments can also be an extremely useful aid in teaching a child about the world of finance and money management.

These are the basic exemptions available to all taxpayers. Beyond them there is nothing to prevent gifts being made which are well in excess of these allowances.

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Gifts to individuals (but not trusts) of any amount in excess of the tax free allowances are initially ignored for IHT – technically they are called “potentially exempt transfers”, or PETs. If you survive for seven years after making a gift it is completely forgotten about.

If not, the total value of gifts made in the seven years before death is included in your estate to calculate the IHT payable. If the total value of such gifts is less than the tax-free part your estate (called the “nil rate band” – currently £325,000) no IHT is paid on the gifts. The gifts effectively reduce the nil rate band that can be used against your estate or reduce the nil rate band that can be transferred to a surviving spouse of civil partner.

If the total value of gifts in the seven years before death is greater than the nil rate band the recipients of the gifts may have to pay IHT. The IHT payable will however be reduced by taper relief if the gifts were made more than three years before death.

The one tax I have not mentioned so far is capital gains tax. This is the tax which often prevents gifts of assets other than cash. A gift is treated as if the assets gifted had been sold. If the asset has increased in value CGT may be payable.

If it has decreased in value and is being transferred to a child, that loss can only be offset against future gains made on gifts to the same child of whatever age. Again it pays to take advice before making gifts of assets other than cash.

• John McArthur is a tax and trust partner at Gillespie Macandrew LLP