There are many misconceptions about the tax implications of making gifts. Consequently, efficient methods may not be utilised in gifting which may result in an avoidable tax bill. From exemptions and allowances, to capital gains taxes, we explore the different rules in the UK & US and how they can interact with each other.
From a UK tax perspective, an individual’s domicile is significant in determining the taxation of gifts. Whilst an individual’s residence plays a key role in other branches of UK taxation, it is fair to say that it is less relevant when it comes to the taxation of gifts in the UK.
The means of taxing gifts in the UK is by virtue of the laws on inheritance tax (IHT). Inheritance tax is charged on the value transferred by a chargeable transfer. A potentially chargeable transfer will either be a lifetime gift or a transfer on death. There is a common misconception that IHT is a death tax. Indeed, when an individual dies, the value of assets left may be subject to IHT. However, an individual making a lifetime gift may also be subject to IHT.
Individuals who are UK domiciled are liable to IHT on transfers of all worldwide assets, irrespective of the location of the assets. However, non-UK domiciled individuals are subject to liable to IHT on transfers of their UK assets only.
Not everyone is required to pay inheritance tax upon their death. If the value of the estate is worth more than the available Nil Rate Band (NRB) of £325,000*, part of it could be liable to tax. The NRB can also be reduced during your lifetime by the value of gifts you make.
Whilst there are various chargeable transfers, the most common lifetime chargeable transfer is that of a gift to a trust. If a UK domiciled individual transfers an asset into a trust, there will be an immediate lifetime inheritance tax charge at a rate of 20%. This charge is calculated on the value of the asset transferred. IHT will only be payable if the value of the asset gifted to the trust exceeds the £325,000 nil rate band.
There are also certain transfers that are completely exempt from IHT such as: Gifts on marriage up to certain limits, gifts of up to £250 to any done, an annual exemption of £3,000 per tax year. Gifts between spouses or civil partners are also exempt from IHT provided that the recipient is UK domiciled.
If a gift made is neither a chargeable transfer nor an exempt transfer, it is classed as a “potentially exempt transfer” (PET). This is treated as an exempt transfer while the donor is alive and will only become chargeable to IHT if the donor dies within 7 years of making the gift. Therefore, the only time an individual will pay IHT whilst they are alive, is if, they make a chargeable lifetime transfer – i.e. a gift to a trust or company. Making a gift during your lifetime and surviving those seven years is a common form of IHT planning.
In the US there is a gift tax regime. US citizens can gift up to $15,000 (2020) per person each year. Essentially meaning individuals can gift up to $15,000 to multiple recipients without incurring gift tax. The annual exclusion of $15,000 can further be increased to $30,000 if you and your spouse are both US citizens and elect to split the gift. To do so, one must file a gift tax return.
US citizens also have an individual estate and gift tax exemption of $11.58m (2020). This means that individuals can leave up to $11.58m to descendants and will not be subject to federal estate or gift tax. A married couple will have a combined exemption amount of $23.16m.
A common exemption from US gift tax is that of tuition paid directly to provider on behalf of someone else. Provided such payments are used wholly for purposes relating to student expenses, they will not be considered gifts for US tax purposes.
As a result of the significant lifetime exclusion, while gifts in the US will often need reporting to the IRS on a gift tax return, most will be within the exemption regardless of whether they are gifts to individuals or a trust. The size of the US exemption ($11.58m) compared to the UK nil rate band (£325k) is one big disparity between the two systems.
It is also worth noting that, those who are not resident in the US for gift and estate tax purposes, are still subject to the gift tax regime in relation to tangible property with a US situs, e.g. US real estate, but have a much lower gift tax exclusion of only $60k.
Lifetime Gifts & Capital Gains Tax
Another big disparity is in relation to capital gains and gifts. A lifetime gift can be considered to be a disposal of assets from one individual to another. As such, this brings about the issue of capital gains tax for the donor.
Gifts between spouses/civil partners are deemed to be on a ‘no gain, no loss’ basis (or non-recognition in the US) so will not be subject to capital gains tax. However, when gifting assets other than cash (exempt from capital gains tax), there are differing tax implications in the UK and the US.
When you gift an appreciated asset, it will be deemed to be disposed at the fair market value on the date of the gift. However, the gift being “a gift” likely means the donor will not be receiving any proceeds and they will need to fund the capital gains tax bill.
If the gift is a business asset such as shares in your personal trading company, then an election can be made to defer the gain. This means that the recipient inherits your base cost and the payment of capital gains tax is deferred until they eventually dispose of the asset. If the recipient ceases to become UK-resident, the capital gains tax will have to be paid.
For US citizens, the making of a gift, is a non-recognition event for capital gains purposes. In most cases, the original cost basis of the gifted asset is also inherited by the recipient of the gift.
The idea of no capital gains tax being charged for US gifts may seem quite attractive. However, it can have negative tax implications for taxpayers who are subject to both UK & US tax by way of double taxation. Gifts that see their fair market value exceed their original cost, i.e. appreciated property, will trigger double taxation.
Let’s take a simple example – in this example the individuals are all UK resident US citizens who are deemed UK domiciled. A mother who wishes to gift shares in a listed company, with large unrealised gain, to her child.
- Having made the gift, the mother files a US gift tax return to report the value of the gift. It exceeds her annual exclusion but is within the exemption amount and no gift tax is due.
- For UK IHT purposes, this gift is neither a lifetime chargeable transfer nor exempt. As such, it is a potentially exempt transfer. The mother does not pay any IHT provided she does not die within 7 years of gifting the shares.
- However, she will be subject to UK capital gains tax immediately. The deemed disposal will be included in her UK tax return.
- For UK purposes, the child receives the shares with an uplifted cost basis. For US purposes, the child receives their mother’s basis in the shares and still has a large unrealised capital gain. When the child decides to sell the shares, they will pay US income tax on the same gain with no foreign tax credit available. In other words, they will have incurred double taxation. The same gain has been charged to tax on the mother and the child.
- In the event of the mother passing away within 7 years, this will also trigger an inheritance tax charge at death on the value of the shares – though it may be covered by any available nil rate band. If her death was within three years this charge could be 40%. A third layer of tax, on top of the double tax on the capital gain.
How can Ingleton help?
Here at Ingleton, we understand the complicated nature of the taxation of gifts. We can help support your taxissues with advice and planning strategies whether you are a US or UK citizen. To find out more, please contact our tax advisors on +44 (0) 207 183 2251 or email firstname.lastname@example.org.
*The Nil Rate Band (NRB) of £325,000 is fixed until 2021