How does HMRC know about gifts for my children? - Gareth Shaw

Dear Gareth, Can you explain please how the government knows how much money I am giving to my children or grandchildren, and whether they should pay inheritance tax? My savings are spread out in various building societies and banks and if I give a gift that exceeds £3,000 in a year, what will happen? How does the taxman know whether a large gift has been given as, for example, a wedding present?  Helen Evans, via email.

Can you explain please how the government knows how much money I am giving to my children or grandchildren?

Gareth says…

This is a really good question, and a timely opportunity to talk about the rules around gifting and inheritance tax.

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There is nothing to prohibit you giving money or other assets to your children or grandchildren, or anybody you want.

However, the amount you give will determine whether or not inheritance tax may be due on your overall estate when you die, and whether any of those gifts become taxable.

Each individual can give away £325,000 free of inheritance tax, increasing to £500,000 if your estate includes a property which is being passed onto a direct descendant (a child or grandchild).

Married couples and civil partners can not only inherit their late spouses assets free of inheritance, but also these tax-free allowances. This means a married couple can pass on £1m in total. Anything above these allowances is charged at 40 per cent.

But there’s more. You can give gifts – up to £3,000 per year (known as an annual exemption), which can be backdated to two years if unused in the previous year, allowing you to give away £6,000 in a single year tax-free.

You can give gifts out of income, so long as they are part of your normal expenditure and don’t impact your standard of living. You can also give wedding gifts of up to £5,000, depending on the recipient, and an unlimited number of gifts of up to £250.

Any gifts that sit outside of these rules are called ‘potentially exempt transfers’.

You’ll need to survive for seven years after giving the gift for them to be exempt from inheritance tax. If you die within that seven-year period, the gifts are added to your estate, effectively reducing the tax-free allowances you have and increasing the possibility that tax may be payable by your heirs when you die.

And this speaks to the heart of your question – HM Revenue and Customs, the government department tasked with collecting taxes, doesn’t know when you’ve given a gift, or how much you’ve given, until you tell it.

The system is built upon self-declaration, not only through self-assessment tax returns when you are living and earning, but also upon death.

The process of dealing with your estate when you die is called ‘probate’, and an executor will be appointed to administer your estate – gathering the details of your estates, your debts and making sure that the wishes laid down in your will are carried out. Once probate has been granted, the executor can start distributing your estate.

However, in order to get probate, your executor will need to complete a form with a declaration of any gifts that have been given, so that HMRC can correctly calculate any inheritance tax liability on your estate. The executor has to sign this to declare that all of the information is truthful and correct.

The penalties for not disclosing any gifts can be high. If a gift has not been declared, any additional inheritance tax will need to be paid, along with potential fines and interest. So while you don’t necessarily have to worry about informing the government of the gifts you make, it will eventually find out.

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