Calculating Inheritance Tax on Gifts: Nil Rate Band and Taper Relief

Calculating inheritance tax on gifts follows a fixed sequence: remove the gifts that are exempt, line the rest up oldest first, set the £325,000 nil rate band against them in date order, then tax anything above that threshold at 40%, reduced by taper relief for gifts made more than three years before death. Get the order wrong and you get the wrong answer, because the chronological rule can shelter a large early gift while leaving a small later one fully taxable.

Why Gifts Get Taxed at All

Any outright gift to another individual is a potentially exempt transfer, or PET. Survive seven years after making it and it drops out of your estate entirely. Die within that window and the gift is pulled back into the inheritance tax calculation as though it were still part of what you owned.¹

The nil rate band, currently £325,000, is frozen at that level through April 2030.² Gifts above that threshold, made within seven years of death, face tax at 40%, subject to taper relief.

Strip Out the Exempt Gifts First

Before the taxable total is calculated, exempt gifts come out of the list entirely. These never count toward the seven-year running total regardless of when the donor died.¹

The £3,000 annual exemption per tax year, which can be split between recipients. Any unused portion carries forward one year only, so a donor who skipped a year could give £6,000 in the next.
Small gifts of up to £250 per person per tax year, provided the annual exemption has not already been used on the same recipient.
Wedding or civil partnership gifts: up to £5,000 from a parent, £2,500 from a grandparent, and £1,000 from anyone else, given to a person getting married.
Gifts to qualifying charities, which are fully exempt with no cap.
Transfers between spouses or civil partners, exempt with no limit on value.
Regular payments out of surplus income, provided they form part of a settled pattern, come from income rather than capital, and leave the donor able to maintain their usual standard of living.³

Each exemption applies per donor. A married couple has two annual exemptions and two sets of wedding allowances between them.

Check for Reservation of Benefit Before You Count Anything

A gift only counts as a gift if the donor genuinely stopped benefiting from what was given. Signing over a house while continuing to live in it rent-free, or handing on a painting that stays on the wall, is what HMRC calls a gift with reservation. The asset stays in the estate as though the transfer never happened, no matter how many years passed.¹ If a gift on the list turns out to fall into this category, it comes off the seven-year workings and back onto the estate return instead.

Apply the Nil Rate Band Chronologically

What remains is the list of taxable gifts. Order them oldest to most recent. Set the £325,000 nil rate band against them starting with the earliest, cumulatively. Once the running total crosses £325,000, every pound beyond that line becomes potentially taxable.¹

This order matters. Earlier gifts absorb the nil rate band first, which can push a modest later gift entirely into the taxable zone even when a much larger earlier gift escaped tax altogether.

Apply Taper Relief to the Excess

For each gift or portion of a gift that falls above the nil rate band, tax runs at 40%, then taper relief reduces the effective rate based on how many years passed between that specific gift and the date of death.¹

0 to 3 years before death: 40%
3 to 4 years: 32%
4 to 5 years: 24%
5 to 6 years: 16%
6 to 7 years: 8%
7 years or more: 0%

Taper relief reduces the rate of tax, not the value of the gift. And it only bites on the amount above £325,000. If total taxable gifts in the seven-year window come to less than the nil rate band, there is no tax to taper in the first place, no matter how old the gifts are.

A Worked Example

Take a donor who made three gifts, after all exemptions have been stripped out: £200,000 to a child six and a half years before death, £200,000 to a friend four years before death, and £50,000 to a sibling one year before death.

The £200,000 gift from six and a half years ago absorbs the first £200,000 of the nil rate band. It sits entirely inside the £325,000 threshold, so no tax is due on it. Taper relief is irrelevant here because there is nothing to tax.

The £200,000 gift from four years ago takes up the remaining £125,000 of the nil rate band, and the other £75,000 spills over. Tax at 40% on £75,000 is £30,000. This gift falls in the four-to-five-year band, so taper relief cuts the effective rate to 24%. The bill on this gift is £18,000.

The £50,000 gift from one year ago falls wholly above the nil rate band, which is now used up. Tax at 40% on £50,000 is £20,000. No taper relief applies because the gift was within three years of death.

The total inheritance tax on the lifetime gifts is £38,000. The largest gift produced no tax because it came first. The smallest gift was taxed in full because it came last.

What This Does to the Estate

Any nil rate band consumed by lifetime gifts is not available again for the rest of the estate. In the example, the £325,000 is entirely gone before probate even begins. The estate itself has no main nil rate band to work with.

A separate residence nil rate band of up to £175,000 may still be available where a home passes to direct descendants, and is likewise frozen through April 2030.² Any nil rate band unused when a spouse or civil partner died earlier can be transferred to the survivor, potentially bringing the main band up to £650,000.

Who Actually Pays

Tax on lifetime gifts is normally paid by the estate. Once total gifts in the seven years before death exceed £325,000, though, the individual recipient of each taxable gift becomes liable for the tax attributable to their gift.¹ Someone who received money years ago, and has since spent it, can end up with an unexpected HMRC bill for tax on their share.

Records the Executor Will Need

Executors report every gift made on or after 18 March 1986 on form IHT403, filed alongside the main return on form IHT400.⁴ For each gift the form asks for the date, the recipient, the asset given, its value at the time, and any exemption claimed.

A running log kept during the donor’s lifetime saves a great deal of trouble. For property and valuables, a professional valuation at the date of the gift is the best evidence of the figure. Bank statements, cheques, and signed deeds of gift back up the paper trail. Anyone relying on the normal expenditure out of income exemption needs more: a record of annual income, regular outgoings, and each payment, showing that the pattern was funded from surplus income rather than capital. The burden of proving that sits with the estate after the donor has died, so the evidence needs to be gathered while it still can be.

1
GOV.UK. How Inheritance Tax Works: Thresholds, Rules and Allowances – Rules on Giving Gifts
2
HM Revenue & Customs. Inheritance Tax Thresholds and Interest Rates
3
GOV.UK. Inheritance Tax Manual IHTM14231 – Lifetime Transfers: Normal Expenditure Out of Income: Introduction
4
GOV.UK. Inheritance Tax: Gifts and Other Transfers of Value (IHT403)