Loading…

Tax considerations for separation and divorce.

Separation or divorce is never easy, and sadly, the current global pandemic is unlikely to make it any easier. Some reports suggest the additional strain on relationships will result in an increase in the number of divorce filings, once the period of isolation ends.

One of the biggest concerns when dividing marital assets is how to limit financial liabilities to preserve wealth. So, although tax may not be at the top of the list of priorities when dealing with a divorce, it is extremely important that you seek the advice of a tax specialist as early as possible in the planning process, in order to prevent the nasty surprise of unexpected tax bills.

Here, we discuss what these tax implications are and how you can prepare for them:

Capital Gains Tax (CGT)

If you are married or in a civil partnership, any assets transferred or gifted between you and your spouse/partner are at a “no gain no loss” basis, meaning that no taxable gains arise on the transfer of assets. This rule only applies to spouses that are living together at some point during the tax year. So should you  separate part way through the year, you’ll both have until the following 5h of April to make any transfers to each other without incurring a CGT liability. Therefore, this should be considered carefully before marital assets are divided. 

From the following 6 April, while you are separated but are still legally married or in a civil partnership, you will be connected persons for CGT purposes. This means that any transfers of assets between you  will be deemed to take place at market value, even if no cash has exchanged hands. The result is that the person making the transfer could be left with a CGT liability. 

For example, let’s say that a couple separate on 2 January 2020 (2019/20) with no plans to reconcile. On 14 April 2020 (2020/21), the higher earning spouse transfers £200,000 of quoted shares (originally acquired for £30,000) to the other spouse for no cash, under an agreement. As the transfer is a deemed disposal at market value , the calculation below illustrates their likely CGT liability:

 

Market value of shares

£200,000

Less: Original cost

(£30,000)

Chargeable Gain

£170,000

Less: Annual Exemption

(£12,300)

Taxable

£157,700

CGT @ 20%

£31,540

 

This results in a CGT liability of £31,540 whereas, if the transfer had taken place a few days earlier, i.e. by 5 April 2020, there would be no CGT to pay. As you can see, this can get quite expensive if the assets are of significant value.

It is also worth noting that if instead a loss had arisen on the above transfer, as the spouses are “connected” the loss cannot be used against general gains and can only be utilised against gains arising on future transfers to that same spouse.

Once the divorce has been finalised with the decree absolute, the former spouses cease to be connected persons.

The family home

Typically, the biggest source of contention between couples during the divorce process is the family home. And, after a separation, it is not unusual for one spouse to move out to live elsewhere if staying in the family home becomes unfeasible.

Selling the property

Under general principles, the gain arising on the sale of a residential property which has been an individual’s main residence is exempt from CGT under Private Residence Relief (PRR). However, a married couple / civil partners can only have one main residence between them. If the family home is to be sold and the proceeds divided between you both as part of the divorce settlement, the departing spouse will only qualify for 100% PRR on the gain if the sale takes place within 9 months of them moving out, so long as they have not elected for another property to be treated as their main residence.  Otherwise, a portion of the gain will be chargeable to CGT.

The residing spouse will continue to qualify for 100% PRR on their share of the gain.

Transferring the property to the occupying spouse

In many circumstances, it is not practical to sell the family home. Instead, the departing spouse transfers their (sole or joint) ownership of the family home to the spouse still living in the property as part of the divorce settlement. In the tax year following the date of separation, the departing spouse will be able to claim 100% PRR on the transfer of their share of the property if this takes places within nine months of moving out and a main residence election has not been made on another property. 

A very important point that often gets overlooked is that if the transfer of the family home takes place under a Court order, the departing spouse will be able to claim that the home should be treated as if it continued to be their main residence from the date they moved out to the date of transfer (however long this takes). This essentially extends the last nine month period of ownership rule for PRR and as a result, there will be no charge to CGT for the departing spouse. This is just one example where seeking good tax advice can help to mitigate any unnecessary tax liabilities.

Inheritance Tax (IHT)

Transfers between spouses are exempt from IHT*. This remains true even during the period of separation up until the actual decree absolute. A transfer made after the divorce has been finalised may be a “Potentially Exempt Transfer” (PET). This will be chargeable to IHT if the donor dies within seven years from the date of transfer; which would have the effect of reducing the IHT nil rate band (currently £325,000) available to be allocated against their estate and thereby increasing the IHT liability, leaving beneficiaries with less than what was intended. Bad timing could potentially increase the IHT due on an estate by up to £130,000 (£325,000 x 40%).

It is therefore imperative that any transfers are made at the “right” time.

While getting married often revokes pre-existing wills, getting a divorce does not. As such, it is essential that you seek legal and tax advice when updating your will to ensure that your express wishes are carried out in the most tax efficient manner. 

*There is a lifetime limit of £325,000 for transfers made from a UK domiciled spouse to a non-UK domiciled spouse.

Income Tax 

The transfer of assets under a divorce settlement is not subject to income tax. However, if you have  received income producing assets from your former spouse, such as income bonds or shares, you will be taxable on the interest and dividend income received since the date of legal transfer.

Maintenance payments are generally outside the scope of UK tax. The result is that maintenance payments received do not count as taxable income and similarly, there is no tax relief for maintenance payments made to a former spouse. 

About the author

Akin Coker

+44 (0)20 7556 1332
cokera@buzzacott.co.uk

One of the biggest concerns when dividing marital assets is how to limit financial liabilities to preserve wealth. So, although tax may not be at the top of the list of priorities when dealing with a divorce, it is extremely important that you seek the advice of a tax specialist as early as possible in the planning process, in order to prevent the nasty surprise of unexpected tax bills.

Here, we discuss what these tax implications are and how you can prepare for them:

Capital Gains Tax (CGT)

If you are married or in a civil partnership, any assets transferred or gifted between you and your spouse/partner are at a “no gain no loss” basis, meaning that no taxable gains arise on the transfer of assets. This rule only applies to spouses that are living together at some point during the tax year. So should you  separate part way through the year, you’ll both have until the following 5h of April to make any transfers to each other without incurring a CGT liability. Therefore, this should be considered carefully before marital assets are divided. 

From the following 6 April, while you are separated but are still legally married or in a civil partnership, you will be connected persons for CGT purposes. This means that any transfers of assets between you  will be deemed to take place at market value, even if no cash has exchanged hands. The result is that the person making the transfer could be left with a CGT liability. 

For example, let’s say that a couple separate on 2 January 2020 (2019/20) with no plans to reconcile. On 14 April 2020 (2020/21), the higher earning spouse transfers £200,000 of quoted shares (originally acquired for £30,000) to the other spouse for no cash, under an agreement. As the transfer is a deemed disposal at market value , the calculation below illustrates their likely CGT liability:

 

Market value of shares

£200,000

Less: Original cost

(£30,000)

Chargeable Gain

£170,000

Less: Annual Exemption

(£12,300)

Taxable

£157,700

CGT @ 20%

£31,540

 

This results in a CGT liability of £31,540 whereas, if the transfer had taken place a few days earlier, i.e. by 5 April 2020, there would be no CGT to pay. As you can see, this can get quite expensive if the assets are of significant value.

It is also worth noting that if instead a loss had arisen on the above transfer, as the spouses are “connected” the loss cannot be used against general gains and can only be utilised against gains arising on future transfers to that same spouse.

Once the divorce has been finalised with the decree absolute, the former spouses cease to be connected persons.

The family home

Typically, the biggest source of contention between couples during the divorce process is the family home. And, after a separation, it is not unusual for one spouse to move out to live elsewhere if staying in the family home becomes unfeasible.

Selling the property

Under general principles, the gain arising on the sale of a residential property which has been an individual’s main residence is exempt from CGT under Private Residence Relief (PRR). However, a married couple / civil partners can only have one main residence between them. If the family home is to be sold and the proceeds divided between you both as part of the divorce settlement, the departing spouse will only qualify for 100% PRR on the gain if the sale takes place within 9 months of them moving out, so long as they have not elected for another property to be treated as their main residence.  Otherwise, a portion of the gain will be chargeable to CGT.

The residing spouse will continue to qualify for 100% PRR on their share of the gain.

Transferring the property to the occupying spouse

In many circumstances, it is not practical to sell the family home. Instead, the departing spouse transfers their (sole or joint) ownership of the family home to the spouse still living in the property as part of the divorce settlement. In the tax year following the date of separation, the departing spouse will be able to claim 100% PRR on the transfer of their share of the property if this takes places within nine months of moving out and a main residence election has not been made on another property. 

A very important point that often gets overlooked is that if the transfer of the family home takes place under a Court order, the departing spouse will be able to claim that the home should be treated as if it continued to be their main residence from the date they moved out to the date of transfer (however long this takes). This essentially extends the last nine month period of ownership rule for PRR and as a result, there will be no charge to CGT for the departing spouse. This is just one example where seeking good tax advice can help to mitigate any unnecessary tax liabilities.

Inheritance Tax (IHT)

Transfers between spouses are exempt from IHT*. This remains true even during the period of separation up until the actual decree absolute. A transfer made after the divorce has been finalised may be a “Potentially Exempt Transfer” (PET). This will be chargeable to IHT if the donor dies within seven years from the date of transfer; which would have the effect of reducing the IHT nil rate band (currently £325,000) available to be allocated against their estate and thereby increasing the IHT liability, leaving beneficiaries with less than what was intended. Bad timing could potentially increase the IHT due on an estate by up to £130,000 (£325,000 x 40%).

It is therefore imperative that any transfers are made at the “right” time.

While getting married often revokes pre-existing wills, getting a divorce does not. As such, it is essential that you seek legal and tax advice when updating your will to ensure that your express wishes are carried out in the most tax efficient manner. 

*There is a lifetime limit of £325,000 for transfers made from a UK domiciled spouse to a non-UK domiciled spouse.

Income Tax 

The transfer of assets under a divorce settlement is not subject to income tax. However, if you have  received income producing assets from your former spouse, such as income bonds or shares, you will be taxable on the interest and dividend income received since the date of legal transfer.

Maintenance payments are generally outside the scope of UK tax. The result is that maintenance payments received do not count as taxable income and similarly, there is no tax relief for maintenance payments made to a former spouse. 

Speak to an expert
Speak to an expert

Timing is key, so it is important to seek specialist tax advice from early on in the separation process. If you have any questions, please fill in the form below and one of our experts will be in touch.

Please verify yourself above.
Please complete all required fields above.
close back
Your search for "..."
did not yield any results.
... results for "..."
Search Tags