Divorce and finances - how to avoid the tax man benefitting
4th February 2016 by Fiona Hotston Moore
For most couples getting divorced is an extremely stressful time and there is a lot to think about besides finances and tax. As forensic accountants we assist divorce and family lawyers in agreeing the financial split between couples together with the tax implications of the financial settlement.
Unfortunately, we occasionally come across situations where it is the tax man who receives an unexpected windfall from the divorce, as often substantial tax could have been avoided by getting appropriate tax advice at an early stage in the separation.
Here’s a few guidelines to help you avoid filling the tax man’s coffers:
- Consider how you want to manage the process. The ‘out-of-court' options such as ‘round-the-table’ negotiation or mediation are least stressful and will avoid substantial professional fees. You can ‘do-it-yourself’ without a legal adviser and financial advice but this is probably not advisable, unless your assets are minimal, as you may end up with an unexpected tax liability or inequitable split.
- Gather all the financial information together early and exchange it with your partner (disclosure) so you both understand your joint finances. You will need details of bank accounts, savings, pension pots, any trusts, property valuations, mortgages, loans, credit card liabilities, tax bills etc . You will both need to understand what each other earns and also what you typically spend including household bills, school fees, holidays, cars and so on.
- If one or both of you have an interest in a business you will need the assistance of a forensic accountant to give advice on the valuation of that interest and the options for how you deal with the business. Generally you will seek to preserve the business intact but one party may transfer their interest to the other. It is essential that tax advice is sought on how to undertake any transfer of business interests and/or the extraction of cash from a business. Unfortunately, we have seen individuals end up with a very large and unexpected tax bill after the divorce arising from a transaction involving the business, which was totally avoidable if the individual had received tax advice on how to structure the arrangements.
- A key issue to be considered is the capital gains tax consequences on the transfer of assets together with the timing of such transfers. Capital gains tax does not apply to the marital home but the couple may have a second home, investments or other valuable assets. In addition, capital gains tax issues can arise if either party moves into a new residence on the marriage breakdown. Assets transferred between married couples are exempt from capital gains tax. However, the exemption finishes not at the date of divorce, as most people assume, but rather at the end of the tax year in which couples separate. This can mean if couples separate in say May, they have ten months to agree how to split assets between them, whereas if they separate in March they may have just a matter of days. The unfortunate result could be that one party ends up with a tax bill when in reality they have not received any benefit.
- Generally transfers of assets between spouses are exempt from inheritance tax and this includes assets transferred after divorce as part of the settlement. However tax is complex and advice is essential.
- Following a divorce settlement, an individual may end up with more potential exposure to inheritance tax, for example if they exchange their interest in the family business for cash. Tax advice may help limit inheritance tax and preserve wealth for future generations.
- Maintenance payments now attract no tax relief for the payer (unless either party was born before 6 April 1935) and the recipient pays no income tax on the maintenance received.
- Pension funds are often a significant marital asset and they can be dealt with in a variety of ways such as splitting the fund, agreeing that the eventual annuity paid is split between the parties or offsetting the value of the fund against other assets. Independent financial advice is essential both in terms of the split and future retirement planning.
- During the negotiations each party pays their own legal fees albeit as part of the settlement one party may agree to pay both parties costs. This can pose challenges for the party who has limited access to funds during the negotiations and yet at this point really needs impartial legal and financial advice.
- Access to joint accounts and credit cards etc. can be contentious. You may wish to freeze joint accounts and to cancel credit cards but you will need to ensure provision is made for both parties day-to-day living expenses.
- Finally, we do unfortunately come across cases where one party is attempting, or perceived to be attempting, to defraud the other party by perhaps hiding cash or assets and/or by understating family income perhaps by “forgetting” to disclose share options, bonuses or deferred compensation arrangements. In this area the forensic accountant can assist with an objective review of tax returns, bank statements, business records, trust statements, employer returns, public filings etc.
For further information or help please contact Fiona Hotston Moore.
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