How does inheritance tax taper relief work in practice?

Taper relief reduces the Inheritance Tax payable on gifts made during a taxpayer’s lifetime, providing they survive at least 3 years from making the gift.

Many readers will be familiar with the 7 year rule in relation to making lifetime gifts to mitigate Inheritance Tax: gifts made during a taxpayers lifetime are known as potentially exempt transfers, and will usually be outside the scope of Inheritance Tax after 7 years have elapsed.

For this reason many people gift assets to the next generation/s during their lifetimes in the hope of escaping a 40% Inheritance Tax charge for their beneficiaries to pay when they die. Providing the donor doesn’t continue to derive a benefit from the asset gifted then this usually represents simple and effective Inheritance Tax planning.

But what if you don’t live for 7 years after making the gift? There is a measure called taper relief which reduces the tax payable on gifts once 3 years have elapsed from making the gift. It works on a sliding scale with the tax on gifts reducing by 20% where the donor survives 3 to 4 years, by 40% where they survive 4 to 5 years, 60% where they survive 5 to 6 years, and 80% where they survive 6 to 7 years after making the gifts. This means that an Inheritance Tax saving is achieved after just 3 years.

But does it? A common misconception with taper relief is that it reduces the value of the lifetime gifts to be taken into account when drawing up the Inheritance Tax account on death. In actual fact, taper relief reduces the tax on the lifetime gifts, but not the value of those gifts. Same thing right? Unfortunately not, as when the estate calculation is made, the Inheritance Tax nil rate band (currently £325,000 per taxpayer, and with unused nil rate bands transferring to surviving spouses) is first applied to the lifetime gifts, and then the remainder to the estate upon death.

This means that any lifetime gifts valued below the nil rate band will not get the benefit of taper relief at all, and only the remainder of the nil rate band is available to use against the remaining estate upon death.

However, while the way in which taper relief works is often misunderstood, it is still a very valuable relief, particularly for higher value estates, and making lifetime gifts continues to be an effective planning tool for most families.