Interactive Investor

Tax trap: understand these rules and avoid a massive tax bill

22nd November 2022 11:17

by Alice Guy from interactive investor

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Alice Guy explains how a little-known double tax trap could leave you and your descendants with a sour taste.

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With Christmas fast approaching, the newspapers are full of gift ideas for mums, dads, aunties, uncles and even dogs and cats. As a mum of four kids, it’s a big job working out what Christmas gifts to buy and the wrapping up is a seemingly endless task.

But beyond the Christmas gift-giving, many of us are also considering financial gifts to help out our children or wider families. It can be a great way to help the next generation on to the housing ladder, invest for their future or pay for spiralling living costs.

If you’re thinking about passing on wealth, then it’s important to weigh up the tax implications. There are lots of fiddly rules and tax traps that could mean you end up paying more than you want to the taxman.

In fact, there’s a little-known tax trap where if you give away assets and end up not surviving seven years, you could be stung with both capital gains tax (CGT) and inheritance tax (IHT) on the same assets. You and your family could be facing a combined 57% total tax bill, including both taxes.

More of us paying IHT and CGT

Capital gains tax and inheritance tax were originally aimed at the super-rich and intended to stop the extremely wealthy piling up yet more wealth. If you’re part of that super-wealthy class you can afford to pay for all the tax planning advice you need so, arguably, fiddly tax rules don’t really matter.

But things have changed and the ongoing freezing of tax allowances and the future reduction of the CGT threshold means more and more of us are now paying these wealth taxes. And yet the rules are extremely complicated and not commonly understood.

Potential double tax on gifts

Because capital gains tax and inheritance tax are completely separate taxes, you could end up owing both taxes on the same assets. Here’s how it works.

If you give away assets during your lifetime, you could owe capital gains tax as if you’d sold them. Many people don’t realise that CGT is charged on gifts: the gain is based on the market value of the gift minus the original purchase price. Shareholders and property investors are particularly affected as they have often seen huge increases in value if they’ve owned their assets for a long time. Your main home is usually exempt from CGT.

You’re allowed to give gifts to your spouse without owing CGT, but gifts to children or unmarried partners are potentially chargeable. Some people fall foul of this rule when they split up from an unmarried partner and divvy up assets between them.

Because inheritance tax is a completely separate tax to capital gains tax, your beneficiaries will potentially need to pay 40% IHT on any assets you gave away within seven years of your death.

If you die within seven years of making a gift, it will be counted as part of your estate and your beneficiaries could end up owing 40% IHT on the gift. There are also exemptions and allowances including a £325,000 nil rate band and £175,000 allowance for your main residence which reduce many people’s IHT bill.

You can give away up to £3,000 each tax year and use the annual exemption rules to put that gift immediately out of your estate. You can also pass on gifts out of regular income and avoid inheritance tax, but you’ll need to be able to prove you didn’t need the income, so it’s important to keep records.

An example

If someone gave away a property worth £300,000 that they bought years ago for £100,000, they would have a profit of £200,000 for CGT purposes and could use their annual exemption to reduce their gain by £12,300.

The giver would owe £52,556 CGT on the gain (28% of £187,700) as CGT is charged at 28% on second properties. The annual exemption is reducing to £6,000 in April 2023 and then £3,000 by 2024, so even more CGT will be due.

If the giver then died within three years of making the gift, their estate would owe IHT on the full £300,000, assuming they had used up their IHT allowances.

Their beneficiaries would owe £118,800 IHT after the giver's death (40% of £297,000, which is £300,000 minus the £3,000 annual allowance), giving a whopping combined tax bill of £171,356.

That tax bill is 57% of the £300,000 sale price and will increase to 58% in April after the CGT annual allowance reduces.

Assets given away

Sale value

Profit made

CGT due at current rate

CGT due in 2024

Inheritance tax

Total current tax bill

Total tax bill in 2024

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Second home








Assuming giver dies within three years of the gift and all IHT allowances used up

Assuming giver is a higher rate taxpayer.

If you’re thinking about giving gifts to your family or an unmarried partner, then it’s important to get tax advice to make sure you weigh up all the tax implications. A specialist solicitor will be able to advise you on the best course of action and also highlight any potentially taxable assets and possible tax to pay before you give them away.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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