How to Work Out Inheritance Tax Due on Gifts to Minimize Liability and Avoid Penalties

Inheritance tax is one of those topics that can make anyone’s head spin. But if you’ve ever given or received a large gift, or plan to pass assets to loved ones, understanding how inheritance tax (IHT) works is absolutely essential.

In this blog post, we’ll break down how to calculate inheritance tax on gifts in the simplest way possible. Whether you’re a parent gifting money to your child, or someone receiving a generous gift, this guide will help you understand the rules and make smart decisions to minimize your liabilities and avoid penalties.

What Is Inheritance Tax on Gifts?

Before we dive into calculations, let’s clarify what inheritance tax on gifts actually means.

In the UK, some gifts you give during your lifetime may be counted as part of your estate when you pass away. If the total value of your estate exceeds a certain threshold, inheritance tax might be due. One common misunderstanding is that gifts are always free of tax if given before you die—but that’s not always the case.

So, what counts as a gift?

It could be:

• Money
• Property or land
• Possessions like jewellery, cars, or antiques
• Sale of an asset at below its market value (such as selling your house to your child at half price)

Still with me? Good. Now let’s explore how to work out if inheritance tax is due — and if it is, how much.

When Is Inheritance Tax on Gifts Charged?

Not all gifts are taxed. The timing of the gift is important — and this is where something called the “seven-year rule” comes into play.

The Seven-Year Rule Explained

Let’s say you gave a large gift and then lived for more than seven years after making that gift. Congratulations! That gift is completely tax-free.

But, if you pass away within seven years of making the gift, it may be subject to inheritance tax. Here’s how that works:

• If you die within 3 years: the gift is taxed at the full 40% inheritance tax rate
• If you die between 3 to 7 years after giving the gift: a reduced tax rate applies, through a method known as “taper relief”

Taper Relief Rates

Note: Taper relief only applies if the total value of gifts given exceeds the £325,000 threshold (known as the ‘nil-rate band’).

How to Work Out If Inheritance Tax Is Due on a Gift

Here’s a clean step-by-step process to help you:

Step 1: Add Up the Value of Gifts Given in the Last 7 Years

If the person giving a gift dies, the executor of their estate needs to check whether they gave any gifts in the last 7 years. This includes birthday presents, Christmas gifts, or even payments made to help with rent or school fees.

Make a list, along with the date and value of each gift.

Step 2: Subtract Any Exempt Amounts

Certain gifts are automatically exempt from inheritance tax:

• £3,000 annual exemption: You can give away up to £3,000 each tax year without it counting toward IHT.
• Small gifts exemption: Gifts of up to £250 per person per tax year are exempt.
• Wedding gifts: Up to £5,000 for a child, £2,500 for a grandchild, £1,000 for a friend or relative.
• Gifts from surplus income: If you can afford to give away money regularly from income (not savings) without affecting your lifestyle, these might be exempt.

Subtract any of these exemptions from the gift totals.

Step 3: Compare Against the Nil-Rate Band

If the total value of gifts (after subtracting exemptions) is less than £325,000, and the person dies within 7 years, no inheritance tax is due.

But amounts over that? Those may be subject to IHT using the taper relief table above.

Who Pays the Inheritance Tax?

Here’s where people often get tripped up. If tax is due on a gift, who’s responsible for paying it?

• If the gift was given to an individual: That person (the recipient) is usually responsible for paying the IHT.
• If the gift was given to a trust or a company: The estate may cover the IHT due.

But in many cases, the donor (the person who made the gift) works this out in advance with legal or financial advice to avoid surprises.

Real-Life Example

Let’s bring this to life with an example:

Michael gave £500,000 to his two children five years before he died. He hadn’t used any of his £3,000 annual exemption in that tax year.

• Total gift: £500,000
• Less annual exemption: £3,000
• Taxable Gift: £497,000
• Nil-rate band: £325,000
• IHT liable amount: £172,000 (i.e., £497K – £325K)
• Years between gift and death: 5
• Taper relief rate: 16%
• IHT due: 16% of £172,000 = £27,520

So, in this example, the children would owe a total of £27,520 in tax between them unless it was arranged to be paid from the estate.

How to Avoid Inheritance Tax on Gifts

No one likes the idea of handing part of their hard-earned money over to the taxman. Here are practical ways you can legally reduce or eliminate inheritance tax on gifts:

1. Use Your Exemptions Every Year

Think of your £3,000 annual exemption like a tax-free allowance. Use it every year – and if you didn’t use it last year, it can be carried forward for one year.

2. Make Regular Gifts from Income

If you don’t need all your salary or pension to live on, use the excess to gift. These are potentially exempt as long as you can prove it was your disposable income. Keep clear records!

3. Start Planning Early

The earlier you start gifting, the more likely you’ll outlive the seven-year rule. Time really is your best friend when it comes to estate planning.

4. Get Legal Advice

Inheritance tax rules are complex, and mistakes can be costly. A solicitor or financial adviser who specializes in estate planning can help you make the most of your exemptions and allowances.

What Happens If You Don’t Report Gifts?

Here comes the serious bit. If you don’t correctly report gifts made within seven years of death, or miscalculate the values, HMRC may impose interest or penalties. Inaccurate reporting can delay probate and cause legal complications down the line.

Final Thoughts

Inheritance tax on gifts doesn’t have to be terrifying. With a bit of planning, good record-keeping, and a solid grasp of the rules, you can gift smarter—and ensure more of your wealth goes to your loved ones, not to taxes.

Still wondering how this all applies to you? Don’t be afraid to speak to an estate planning professional. A little help now can save a lot of money (and stress) later on.

Remember: It’s not just about how much you give, it’s about when and how you give it.

Need More Details?

If you’d like the full scoop straight from the source, feel free to visit the official government guidance page:

https://www.gov.uk/guidance/work-out-inheritance-tax-due-on-gifts