Definition§
A Potentially Exempt Transfer (PET) is a lifetime gift made by an individual which is considered for inheritance tax (IHT) purposes. PETs are not immediately liable to IHT upon transfer. The main condition for a PET to be exempt is that the donor must survive for seven years following the date of the gift. If the donor dies within this seven-year period, the gift may become part of the donor’s estate for IHT calculations with possible tax liabilities.
Key Points§
- No Immediate Charge: There is no immediate inheritance tax charge when a PET is made.
- Seven-Year Rule: If the donor survives for seven years from the date of the gift, it becomes fully exempt from IHT.
- Tax Liability If Death Occurs Within Seven Years: If the donor dies within seven years, the transferred assets are counted back into the estate and evaluated for IHT based on the order of giving.
- Nil-Rate Band: Gifts are covered by the nil-rate band (0% tax rate) if they fall under a specified threshold (£325,000 for the tax year 2016-17).
- Graduated Relief: Gifts made between three and seven years before death may qualify for graduated relief, reducing the tax burden.
Examples§
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Mr. Smith Makes a Gift to His Daughter:
- In 2016, Mr. Smith gifts his daughter £100,000.
- He survives the next seven years; hence, this gift is exempt from IHT.
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Mrs. Johnson Transfers Property to Her Son:
- In 2010, Mrs. Johnson gives a property worth £350,000 to her son.
- If she dies in 2014, her estate will undergo IHT calculations. The £325,000 nil-rate band would apply first, and then any excess would be subject to graduated relief or the standard rate.
Frequently Asked Questions§
Q1: What qualifies as a Potentially Exempt Transfer (PET)?
A1: Any lifetime gift made by an individual that is not an exempt transfer for IHT purposes qualifies as a PET. The major condition is the survival of the donor for seven years post-transfer to be fully exempt from IHT.
Q2: How is Inheritance Tax calculated if the donor dies within seven years?
A2: If the donor passes away within seven years, the gifts within that time are reviewed. The first £325,000 worth of gifts, known as the nil-rate band, are not taxed. Any value above this involves tax calculations and may benefit from graduated relief between years three and seven.
Q3: Is there a scenario where a PET does not become chargeable upon the donor’s death within seven years?
A3: If the total lifetime gifts in the seven years preceding the death do not exceed the nil-rate band threshold, they remain untaxed. Any gifts beyond that threshold would have been subjected to tax.
Related Terms§
- Inheritance Tax (IHT): A tax on the estate of the deceased, including money, property, and possessions.
- Chargeable Transfer: A transfer of assets upon which inheritance tax is payable because it isn’t exempt.
- Nil-Rate Band: The threshold below which the estate (or gifts) does not attract inheritance tax.
- Graduated Relief: A reduction in inheritance tax applicable to gifts made between three to seven years before the donor’s death.
Online References§
Suggested Books for Further Studies§
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“Personal Tax Planning: Principles and Practice” by Malcolm Finney
- This book provides a comprehensive overview of personal tax planning including inheritance tax and PETs.
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“Practical Inheritance Tax Planning” by Mark McLaughlin
- A practical guide detailing various strategies around IHT including potentially exempt transfers.
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“Tolleys Tax Planning for Individuals” by Helen Adams
- An extensive text covering the key tax planning concepts, strategies including PETs.
Accounting Basics: Potentially Exempt Transfer Fundamentals Quiz§
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