Mark McLaughlin looks at how and when inheritance tax taper relief can apply.
Many individuals without much knowledge of inheritance tax (IHT) will nevertheless be aware of a ‘seven-year rule’ for escaping IHT on lifetime gifts.
The seven-year rule
In broad terms, the ‘seven-year rule’ is shorthand for the general principle that if (for example) a parent gifts an asset to their adult child, the gift is a ‘potentially exempt transfer’ (PET), which normally becomes exempt from IHT if the parent survives for at least seven years after making the gift. A seven-year period is also relevant to ‘chargeable lifetime transfers’ (CLTs). If the parent had instead gifted the asset to a discretionary trust, the gift would be taxed in the first instance at 20% to the extent that the IHT nil-rate band (£325,000 for 2025/26) was used up by earlier CLTs.
If the parent dies within seven years of making the PET, the gift is converted into a chargeable transfer. IHT becomes due at the ‘death rate’ (40% for 2025/26). Furthermore, if the parent dies within seven years of making the CLT, the IHT is recalculated by reference to the death rate.
Taper relief to the rescue!
However, if the parent (in the above example) dies more than three years but within seven years of making the gift, resulting in IHT becoming due on the ‘failed’ PET, or additional IHT becoming payable on the CLT, taper relief is generally available to reduce the IHT rate on those gifts (IHTA 1984, s 7(4)).
Taper relief broadly reduces the full rate of IHT to a percentage of that rate, as follows:
Transfer before death % of full rate
|
More than three years |
Less than four years |
80% |
|
More than four years |
Less than five years |
60% |
|
More than five years |
Less than six years |
40% |
|
More than six years |
Less than seven years |
20% |
Note that it is not the value of the gift that is reduced; it is the rate of IHT. Thus, no taper relief is available if the gift was within the donor’s nil-rate band.
Example 1: Failed PET
Max makes a cash gift of £425,000 to his best friend Patrick and dies four-and-a-half years later (IHT annual exemptions are ignored):
IHT on the gift: £
First £325,000 NIL
Next £100,000 x (40% tapered to 60% thereof) 24% 24,000
Example 2: CLT – IHT on death
Jane transferred £500,000 into a discretionary trust for her nieces and nephews. She dies three-and-a-half years later (IHT annual exemptions are ignored):
IHT on the gift when made: £
First £325,000 NIL
Next £175,000 x 20% 35,000
IHT on death:
£175,000 x (40% tapered to 80% thereof) 32% 56,000
Less: IHT on the gift when made (35,000)
Additional IHT due 21,000
If the IHT on a CLT recalculated on death with taper relief results in a lower IHT figure than the 20% IHT originally paid, the earlier 20% IHT calculation stands; there is no IHT refund. Thus, the CLT cannot benefit from taper relief on death after five years, as the resulting IHT rate on death (i.e., 40% x 40% = 16%) is lower than the 20% lifetime IHT paid.
Practical tip
Consider insuring against the possibility of IHT (or additional IHT) becoming payable on a lifetime gift due to death within seven years, particularly in the first three years.
