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Normal expenditure out of income

Lifetime transfers that constitute a donor’s ‘normal expenditure out of income’ will pass immediately free from inheritance tax.

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Published 26 October 2021

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Gifts Out of Expenditure

Although lifetime giving can be tax-efficient, inheritance tax will arise immediately if the donor makes outright gifts or transfers into trust in excess of their nil rate band (currently £325,000), and will also arise if the donor fails to survive an outright gift by at least seven years.

However, lifetime transfers that constitute a donor’s ‘normal expenditure out of income’ will pass immediately free from inheritance tax.  The exemption applies if each of three criteria are met:

  • Payments are made out of the donor’s ‘normal expenditure’, meaning that they must be typical of the donor according to a settled pattern of behaviour over time.
  • Payments are made out of the donor’s income (as opposed to capital). HMRC’s view is that the donor’s income is their net income after the payment of income tax.
  • Having made the gift(s), the donor is left with sufficient income to maintain their usual standard of living. This means that a donor can only make gifts under this exemption up to the value of their ‘surplus’ income after payment of normal expenses to maintain their usual standard of living.

The ‘normal expenditure out of income’ exemption can be a highly effective tool for lifetime giving where the donor makes regular, manageable gifts over a period of years.  This might include for example payments for a grandchild’s education or the incremental funding of a trust out of the donor’s surplus income.  It is worth remembering however that if a donor survives outright gifts by at least seven years then the gifts will generally pass free from inheritance tax anyway.

This article is part of a series of lifetime giving articles. Read about charitable giving here.

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Shorter Reads

Normal expenditure out of income

Lifetime transfers that constitute a donor’s ‘normal expenditure out of income’ will pass immediately free from inheritance tax.

Published 26 October 2021

Associated sectors / services

  • Private Wealth
  • UK trusts, tax and estate planning

Authors

Gifts Out of Expenditure

Although lifetime giving can be tax-efficient, inheritance tax will arise immediately if the donor makes outright gifts or transfers into trust in excess of their nil rate band (currently £325,000), and will also arise if the donor fails to survive an outright gift by at least seven years.

However, lifetime transfers that constitute a donor’s ‘normal expenditure out of income’ will pass immediately free from inheritance tax.  The exemption applies if each of three criteria are met:

  • Payments are made out of the donor’s ‘normal expenditure’, meaning that they must be typical of the donor according to a settled pattern of behaviour over time.
  • Payments are made out of the donor’s income (as opposed to capital). HMRC’s view is that the donor’s income is their net income after the payment of income tax.
  • Having made the gift(s), the donor is left with sufficient income to maintain their usual standard of living. This means that a donor can only make gifts under this exemption up to the value of their ‘surplus’ income after payment of normal expenses to maintain their usual standard of living.

The ‘normal expenditure out of income’ exemption can be a highly effective tool for lifetime giving where the donor makes regular, manageable gifts over a period of years.  This might include for example payments for a grandchild’s education or the incremental funding of a trust out of the donor’s surplus income.  It is worth remembering however that if a donor survives outright gifts by at least seven years then the gifts will generally pass free from inheritance tax anyway.

This article is part of a series of lifetime giving articles. Read about charitable giving here.

Associated sectors / services

  • Private Wealth
  • UK trusts, tax and estate planning

Authors

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