It may not generate that much revenue for the Government’s coffers, but inheritance tax remains a thorny political issue – and it is set to get even thornier, as property prices continue to soar during the ongoing pandemic.
ritics decry inheritance tax as a form of double taxation, while others argue that it helps to reduce wealth inequality and improve public finances.
Indeed, the OECD recently made the case for higher inheritance taxes as a way to help pay for pandemic supports – so it remains to be seen if the Government will listen to calls to lift the tax-free thresholds.
By the OECD’s standards, Ireland has a relatively progressive inheritance tax regime, although the threshold for children inheriting from parents is much higher than for those who are not direct descendants. The result is that wealthier families are far more likely to inherit than the least well-off families.
Irish families can leave up to €335,000 to each of their children before those children face any tax bill. But that figure falls to €32,500 for other close relatives, and to €16,250 for more distant relatives or friends.
The Government has defended this regime on the basis that, as the family home is the main item making up an estate, a lower threshold would force children inheriting one from a parent to sell it in order to meet the tax liability.
However, relentless house price inflation has led to increasing numbers of families, particularly in Dublin, facing big capital acquisitions tax (CAT) bills because the homes they are inheriting – even modest homes – are worth significantly more than the tax-free threshold of €335,000.
The latest figures from the CSO show that households paid a median or middle-range price of €265,000 for a home in the Republic over the past year, while in Dublin the median price was €390,000.
Back in 2009, the tax-free threshold was just over €540,000. In 2015 it was cut to €225,000 and it has slowly crept back up since then.
There’s no doubting that more people have found themselves in the inheritance and gift tax net. Revenue figures show that 16,000 people paid €522m in 2019 – more than double the amount paid by nearly 11,000 people in 2010.
So what are the ways to avoid or lessen gift or inheritance taxes that may have to be paid on any assets that you pass on in the event of your death?
Small gift exemption
It’s well known that you can inherit a total of up to €335,000 from a parent over the course of your lifetime without paying any tax on it, and that any amount over this threshold is subject to CAT at 33pc. Similarly, you can inherit up to €32,500 tax-free from a close relative, such as grandparents, an uncle or aunt or a brother or sister, and up to €16,250 from someone with whom you have no blood relationship.
What’s less well known is that you can gift up to €3,000 a year to anyone without them having to pay CAT. Known as the small gift exemption, it also means that such gifts below €3,000 a year won’t count towards the total inheritances a person might receive before they hit their parent-to-child tax-free thresholds.
For example, a couple could give their daughter and her family up to €30,000 every year if she has three children (€3,000 from each parent for the daughter, the son-in-law and three children).
“This is the easiest way of managing gifts and inheritance if you have the foresight and means to do it,” says Marian Ryan, consumer tax manager at Taxback.com.
“Where we commonly see it is in parents, grandparents and godparents who will purchase prize bonds or savings bonds in the child’s name in small amounts consistently throughout the child’s life, which can amount to a substantial amount when they reach 18 or 21 years of age – but because they amounted to less than €3K a year, it is below the threshold, so no tax is due on them.
“Outside of this I think the small gift exemption is underutilised.”
It’s also worth bearing in mind that the gift also doesn’t have to be cash as long as it’s worth under €3,000 – it could be jewellery, cars, shares, for example.
Dwelling house exemptions
This is one of a number of exemptions that could be claimed from capital acquisitions tax, but it would entail a bit of a lifestyle change. It’s also more restrictive than it used to be, as the rules were tightened up in 2016.
Under this relief, if a child lives in the family home for three years leading up to the gift or inheritance (and has no other property themselves), the parent can then gift it to them tax-free, as long as the child then stays in the property for six years after the handover and doesn’t own other property in that time.
A couple of exemptions to the six-year rule are if you are over 65 by the time you inherit the property, or if you have to live elsewhere because of your employment, or due to a mental or physical disability.
Get married
If you are married or in a civil partnership and you die before your spouse, they won’t pay any capital acquisitions tax on any gifts you pass on to them. So this is a bit of an extreme move – but if you want to pass on your assets to someone who is not a member of your family or your life partner, you could legally marry them.
“We have heard, anecdotally, of people who are single entering into a civil partnership or marriage so that they can leave an inheritance to either their life partner or a good friend to avoid the large tax bill associated with it,” said Ryan.
Indeed, there was much coverage given to the case of two straight friends, Michael O’Sullivan and Matt Murphy, who married in 2017 so as to avoid the inheritance tax of €50,000 on the house that Murphy intended to leave to O’Sullivan in his will.
What is more commonly done by non-blood related people who want to gift something, or leave an inheritance to someone, is they avail of the small gift exemption over a long period – if they have the foresight, says Ryan.
Take out a Section 72
There are insurance policies you can take out that will cover the CAT tax bill that might apply to whoever you are gifting a large inheritance.
Known as a Section 72 policy, the relief is approved by Revenue to allow people cover the cost of death taxes.
It is structured as a whole-of-life policy – but it is expensive. If a child receiving an estate is facing a tax exposure of €66,000 arising out of inheriting a house worth €535,000, the monthly cost of taking out a Section 72 policy of €66,000 with Royal London (for a non-smoking, 50-year old) would be €93 a month, according to Joey Sheahan of MyMortgages.ie.
Another issue is that the policy must be paid, without any breaks, for at least eight years before the proceeds are exempt from gift tax.
It could be something that the children are asked to cover the cost of, given that it will help them avoid taxes when they inherit.
How to avail of small gift exemption tax relief
The small gift exemption looks like a valuable tax relief, so why isn’t it more popular?
When it comes to inheritance tax, most financial advisors will be quick to recommend that everyone should avail of the small gift exemption.
Through this tax relief you can gift up to €3,000 a year to anyone, without them having to pay CAT (capital acquisitions tax), and which doesn’t count towards the recipient’s total accumulated lifetime inheritance tax-free threshold.
But it remains something of an underused tax relief, as there can some practical and real-world issues with it that prevent it being used more widely.
The first potential issue is liquidity, as your assets may be tied up in pensions or property, meaning that you can’t turn it into cash easily or quickly – but if you have instant access to your funds, then it’s certainly a great option.
Are there any limits affecting the operation of the small gift exemption?
You can gift as many chunks of €3,000 to any number of individuals, every year. For example, a child could get €18,000 tax-free every year from four grandparents and two parents.
There is no limit on how much someone can receive in any tax year under the exemption, except that no more than €3,000 comes from any one person. There is also no upper limit on the number of times you can use the exemption, nor does it matter if you children are under or over 18.
Are there many forms to fill or hoops to jump through to claim small gift exemption?
Exploiting the small gift exemption to the full for your children would require some considerable intergenerational co-ordination and some gentle ‘reminders’, which could get awkward. No-one likes asking for money, after all.
There are some savings plan products which are designed specifically around the small gift exemption that may be worth checking out, such as ones from Irish Life or Standard Life.
It’s also worth bearing in mind that the gift also doesn’t have to be cash, so long as it’s worth under €3,000 – it could be jewellery, cars, or shares, for example. Of course, if any individual item is worth more than €3,000 the balance of the value over this amount may reduce the recipient’s lifetime inheritance tax-free threshold.
Can the small gift exemption tax relief be used to help your children buy a home?
If you wanted to grant a substantial loan to one of your children – such as to help them buy a property – you would have to charge a rate of interest based on what the market charges for personal loans to avoid it being classed as a gift for tax purposes.
But you could also use the exemption to offset the interest bill. For example, if you loaned your child €15,000 at a market rate of 10pc, that would result in an annual interest bill of €1,500 that you could discount using this relief, leaving you with €1,500 left within the exemption for that year.
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