When a relationship ends, probably the last thing you will think about is the effect it will have on your tax position. But ignoring the tax effects of a divorce or separation, can leave unexpected liabilities when funds can be at their tightest.
Whilst the income tax advantages for the married (and those in civil partnerships registered under the Civil Partnership Act 2004) are currently quite low, there are still substantial capital gains (CGT) and inheritance tax (IHT) advantages for the married as opposed to those merely co-habiting. The principal attraction is the fact that transfers of assets between spouses are exempt from CGT, and in most cases, also exempt from IHT. When a relationship breaks down, these exemptions are put at risk, or lost entirely.
Starting with CGT, the spousal exemption for CGT is only available in a tax year where both spouses are living together as a (married) couple at some point during that tax year. Therefore, if the relationship breaks down at the end of March, there is virtually no time before CGT becomes potentially chargeable. If instead the relationship broke down, say at the end of April, there is almost a whole year to plan transferring assets free of CGT. Once the first April 5th following the separation has passed, even if the couple remain legally married CGT is an issue. This fact must be remembered when considering an amicable matrimonial settlement outside of a court order. Assets suddenly becoming chargeable to CGT on a transfer to the other person could include not only items such as share portfolios and valuable heirlooms, but also shares in a business and the matrimonial home.
For qualifying business assets transferred between spouses after separation but before decree absolute, it is usually possible to sign a joint CGT election so that any gains are held over (under the normal Business Gift rules) and the recipient takes over the original purchase cost. However, this would mean that the recipient could suffer a larger potential gain and both parties may therefore find that they cannot agree to sign the election in the first place
For the matrimonial home, any gain on your main residence is exempt from CGT, however as soon as one party moves out, it is no longer considered to be their main residence and CGT could accrue. The departing spouse can however dispose of their interest in their former main residence within 18 months of their departure and still claim full main residence exemption. This period can sometimes be extended, provided that the departing spouse does not elect for another house to be their main residence and certain other conditions are met. CGT relief can also be preserved if a house sale is postponed until, for example, children reach 18, if done through a “Mesher” court order effectively transferring the house into a trust.
Turning to Inheritance Tax, unlike CGT, the usual exemption for spouses is not lost until divorce. After that, transfers between former spouses will be potentially chargeable to IHT if the donor does not survive 7 years. Transfers made during your lifetime for the maintenance of your family continue to be immediately exempt from IHT.
Tax implications aside, there is also the sad fact that most divorces are far from amicable when assets and net wealth start being fought over. The divorce courts have become mired in disputes about who has what and where and it is down to Forensic Accountants to do this discovery work quickly and impartially. Forensic Accountants are investigators first and foremost and not just for the big-ticket divorces that make the headlines. Forensic Accountants can seek out hidden assets, concealed wealth and can assess true rather than claimed value which is particularly useful when the one who initiates the divorce has had the time to hide assets and potentially lay disinformation.
The truth is that after the love has died, money starts talking. Whether that is considering your tax position, or tracking down distant hiding places, you should try to set aside emotion and consider your financial affairs carefully.
For further information on any of the above points or to discuss your tax affairs generally, please do not hesitate to contact Robin Beadle.