Inheritance tax planning – What is normal out of income exemption?

Inheritance tax (IHT) is primarily a tax paid on assets upon a person’s death if their assets are above their available tax allowances. Each individual has a personal Nil Rate Band (NRB) of £325,000 (subject to a reduction to account for lifetime gifting) and the potential for a further allowance which is known as the Residence Nil Rate Band (RNRB). The RNRB affords up to £175,000, providing certain conditions are met, including the requirement that residential property forms part of their estate (or previously did form part of their estate) and is left to direct lineal descendants. 

This creates a potential for up to £500,000 for an individual or £1m for a married couple to pass free of IHT. Amounts in excess of the available allowances will be charged for IHT at 40%, unless a further exemption applies. 

It is worth noting that if your estate is in excess of £2m, dependant how much the £2m mark is exceeded, some or all of the RNRB may not be available to you. 

What if someone makes a gift? 

If a person were to make a gift of £100,000 but failed to survive 7 years; the full value of the gift may still be considered to be part of their estate for IHT and would reduce their available NRB amount (£325,000).

Notwithstanding the above, there are certain annual allowances which allow for the following in each tax year without this affecting your IHT position. These include: 

  • small gifts to any one person of up to £250 in total;
  • wedding or civil partnership gifts of up to £5,000 per child, £2,500 per grandchild and £1,000 to any other person;  and 
  • £3,000 to be gifted each tax year; with any unused portion of the £3,000 annual amount to be carried forward to the next tax year only. 

Wat is normal out of income exemption?

If your income exceeds your regular expenditure there is another, lesser known, relief available to you; normal out of income expenditure (NOOIE) for which there is no limit in value and are wholly exempt for IHT. 

In order for NOOIE to apply the gifts must: 

  • form part of your normal expenditure; 
  • be made out of income (not capital) after tax; and 
  • leave you with enough income to maintain your normal standard of living. 

Ultimately, it is for your executors to prove to HMRC that their criteria are satisfied. In order to show that the gifts were part of a normal expenditure, a commitment to making regular gifts would need to be evidenced.

Keeping up to date records  

To provide your executors with all the required information is it important to keep records which show your total income from all sources (pension, interest, dividend, rental or trust sources), some of which may be listed on your annual income tax reports; in addition to your regular expenditure. 

Regularly received income, at a certain point (if not spent) is accumulated and becomes capital. HMRC will usually accept a 2-year period for surplus income to become capital. If you are able to, provide information of your income and expenditure in the 2 years prior to the first gift, you may be able to make use of the unused income in the 2 tax years prior to your first gift. 

The NOOIE exemption is a very useful tool in reducing the overall estate value, and ultimately IHT payable on death. Utilising this exemption forms part of overall estate planning and it is important that advice is obtained in connection with the estate as a whole. 

How Moore Barlow can help

If you wish to discuss how IHT would be applied to your estate and consider your overall estate planning, please contact our specialist Private Wealth Team