A potentially exempt transfer — PET — is the mechanism behind the most famous rule in inheritance tax: give money or assets to another person, survive seven years, and the gift escapes IHT entirely. The "potentially" is the whole story. Until the seventh anniversary, the gift is neither taxed nor safe; it sits in limbo, waiting to see whether you live. Die within the window and the PET "fails", rejoining the IHT calculation — sometimes with tax payable by the person you gave it to, a detail that surprises families at precisely the worst moment.
Here is how PETs actually work, including the two mechanics almost everyone gets wrong: what taper relief really reduces, and the fourteen-year shadow.
The mechanics of a failed PET
When a donor dies within seven years, failed PETs come back into account in date order, earliest first, and are set against the £325,000 nil rate band before the estate gets any of it. That ordering matters: the old gifts eat the band, and the death estate pays 40% on more as a result. Where the cumulative gifts themselves exceed the band, the excess is taxed — and the bill lands on the donee: the child who received £500,000 four years before death can owe HMRC tax on it personally, whether or not the money still exists. Executors report the gift history on the IHT400 schedules, which is why "did Mum make any gifts?" is the first question every probate adviser asks and the one families answer least reliably.
Taper relief: smaller than its reputation
Taper relief is the most misunderstood relief in IHT. It reduces the tax on a failed PET, not the value of the gift — and since tax only arises on gifts above the nil rate band, taper does nothing at all for gifts within £325,000. For the excess, the effective rate steps down with survival: 40% within three years, then 32%, 24%, 16% and 8% through years three to seven. A £425,000 gift where the donor dies in year six: £100,000 over the band, taxed at 16% — £16,000, payable by the recipient. Meaningful, but the widespread belief that "the gift is 80% exempt after five years" is simply wrong, and estate plans built on that belief overpromise by a wide margin.
The fourteen-year shadow
Seven years is not always the whole look-back. Where the donor also made chargeable lifetime transfers — typically gifts into trust — the sequencing bites: a trust settlement made within seven years before a failed PET consumes nil rate band in the failed PET's calculation. Die in 2026 having made a PET in 2021 and a trust transfer in 2015, and that 2015 settlement — eleven years before death — still shapes the tax on the 2021 gift. Anyone mixing outright gifts and trusts needs the order engineered deliberately: as a rule of thumb, trust settlements before PETs, with gaps, keeps the shadow benign; the reverse order can be startlingly expensive. This single sequencing point is where DIY estate plans most often leak six figures.
What is a PET — and what never was
PET treatment covers outright gifts from one individual to another (and to bare trusts and some disabled trusts). Three neighbouring categories behave differently: gifts into most trusts are chargeable lifetime transfers, taxed at 20% up front above the band (our trusts guide covers the regime); gifts covered by exemptions — the £3,000 annual amount, wedding gifts, and the unlimited normal-expenditure-out-of-income exemption — are exempt immediately and never enter the seven-year game at all; and gifts with reservation (the house you gave away but still live in) are not PETs whatever the paperwork says — they stay in the estate regardless of survival, the trap dissected in our property gifting guide.
Also easily missed: a PET of an asset can carry a capital gains tax bill on day one — gifts are disposals at market value — so a "tax-free gift" of a rental property or share portfolio is only IHT-free-in-seven-years, while the CGT is due within weeks or months. The two taxes need planning together, not sequentially.
Running a gifting programme properly
The practices that make PETs work as intended: records — a gift register with dates, values and recipients, kept with the will, because executors reconstruct seven-plus years of history from bank statements otherwise; insurance — a decreasing seven-year term policy written in trust turns the mortality risk on a large gift into a fixed premium, the standard hedge for major transfers; exemptions first — route what you can through the annual and income exemptions so it never needs the seven years; and start earlier — the entire system rewards giving at 70 over giving at 85, and the most common estate-planning failure is not bad structuring but late timing. The £2 million question of whether to give — set against your own security, care costs and the family's readiness — deserves the same rigour as the mechanics.
Our inheritance tax planning team builds and maintains gifting programmes — sequencing, records, insurance and the annual review — with the wider thresholds and payment machinery covered in our IHT rules guide. Seven years is a long race; the trick is starting the clock while time is still cheap.