The “Normal Expenditure Out of Income” exemption is a valuable yet often underutilised provision in UK inheritance tax (IHT) law. Outlined in Section 21 of the Inheritance Tax Act 1984, this exemption allows individuals to make regular gifts from their surplus income without incurring IHT, provided specific conditions are met.
Understanding the Exemption
Unlike other gifting allowances, such as the £3,000 annual exemption, the normal expenditure out of income exemption has no monetary cap. To qualify, the following criteria must be satisfied:
- Regularity of Gifts: The gifts should form part of the donor’s normal expenditure. This implies a consistent pattern or intention, such as monthly or annual gifts. Even a single gift may qualify if it’s part of a planned series.
- Source of Funds: The gifts must be made from the donor’s income, not capital. Income includes earnings, pensions, dividends, and rental income.
- Maintenance of Lifestyle: After making the gifts, the donor must retain sufficient income to maintain their usual standard of living.
Meeting these conditions ensures that the gifts are immediately exempt from IHT, regardless of the donor’s survival period after the gift.
Practical Application
This exemption is particularly beneficial for individuals with surplus income who wish to support family members or contribute to trusts. For instance, a grandparent might set up a standing order to contribute to a grandchild’s education fund. As long as the payments are regular, from income, and don’t affect the grandparent’s lifestyle, they would typically qualify for the exemption.
Importance of Record-Keeping
Proper documentation is crucial to substantiate claims under this exemption. It’s advisable to:
- Maintain Detailed Records: Keep track of all gifts made, including dates, amounts, and recipients.
- Document Income and Expenditure: Record your income sources and regular expenses to demonstrate that the gifts were made from surplus income.
- Express Intent: Consider writing a letter of intent outlining your plan to make regular gifts from surplus income.
These records will be invaluable for your executors and can help prevent disputes with HMRC.
Conclusion
The normal expenditure out of income exemption offers a strategic avenue for reducing potential IHT liabilities while allowing individuals to support their loved ones during their lifetime. By understanding the criteria and maintaining thorough records, donors can effectively utilize this exemption as part of their estate planning strategy.