HMRC alert: Families hit with £1billion raid by 'most feared' tax on inheritance

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Inheritance tax is a 40 per cent levy on the estates of individuals who have passed away

Wealthy families who left it too late to transfer assets to their loved ones were hit with more than £1billion in inheritance tax (IHT) bills over a four-year period, according to new analysis.

Data obtained through a Freedom of Information (FoI) request to HM Revenue and Customs (HMRC) by financial advice firm NFU Mutual reveals that 5,080 estates were liable for IHT on lifetime gifts across the tax years 2020 to 2024.

Said estates came under the IHT bracket after the donors died before the crucial seven-year threshold had elapsed.

Under current rules, non-exempt gifts made during a person's lifetime fall outside the scope of IHT provided the giver survives for at least seven years.

Where death occurs sooner, the gift is drawn back into the estate for tax purposes.

Drilling into the most recent year of data, the 2023-24 tax year alone saw 1,390 estates caught by the rule, collectively paying £315million in IHT on gifts made too close to death.

That works out at roughly £226,000 per estate on average, a significant financial penalty for families who misjudged the timing of their generosity.

The trend towards transferring wealth during one's lifetime is growing as families seek to shrink their potential IHT exposure. Yet the consequences of acting too late can be severe.

The seven-year clock begins ticking from the moment a non-exempt gift is made. If the donor dies before that period expires, the full value of the gift is factored into the inheritance tax calculation on their estate.

Sean McCann, a chartered financial planner at NFU Mutual who conducted the analysis, highlighted a widespread misunderstanding about how taper relief actually operates.

He said: "There is a widely held misconception that if you make a gift and survive at least three but less than seven years, the inheritance tax due on the gift reduces on a sliding scale.

"However, what happens in practice is that any gifts made in the seven years before death 'eat' your £325,000 tax free allowance first, with the tapering of the tax only applying to any part above £325,000."

He illustrated the point with two scenarios: "As an example, if you make a non-exempt gift of £100,000 and die six years later, this will reduce your standard £325,000 tax-free allowance to £225,000 and there will be no tax to pay on the gift.

"However, if you make a non-exempt gift of £425,000 and die six years later, the first £325,000 would 'eat' your full tax-free allowance and the £100,000 balance of the gift would be chargeable at 40 per cent (£40,000) but you would benefit from a reduction of 80 per cent of the tax due, giving a tax bill of £8,000."

Mr McCann said the rush to gift is likely to intensify as a major policy change looms. From April 2027, pension pots will be brought within the scope of inheritance tax for the first time, a shift that could dramatically increase the number of estates facing a liability.

He shared: "Inheritance tax is one of the most feared and least understood taxes.

"It's possible we could see changes in the gifting rules in October's Budget, with restrictions on some of the exempt gifts including 'gifts from normal expenditure' which allows you to give away unlimited regular gifts from income immediately exempt from IHT provided it leaves you with sufficient income to maintain your standard of living."