DIVORCE – THE TAX ASPECTS

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Introduction 

Approximately 42% of marriages end in divorce. The percentage is likely to increase as a result of COVID-19 lockdown and the resulting strain on relationships which may have been already under stress. Whilst taxation is not necessarily the first thing on a divorcing couple’s mind, it is important to understand the key issues. 

It is vital for a divorcing couple to seek our advice on the tax implications of separation, divorce and any proposed settlement at the earliest opportunity. By planning a divorce settlement carefully, you should be able to minimise the tax cost of transfers under the divorce settlement. This can in turn help to leave as much as possible for distribution between the divorcing spouses. 

Income Tax, Capital Gains Tax and Inheritance Tax (IHT) all need to be considered in formulating a divorce settlement, and in establishing the tax position for both parties going forward once the settlement has been made.  

Capital Gains Tax (CGT)  

In a marriage, either partner can transfer assets to the other with no tax implications so long as they can prove they lived together during the tax year in question and have not separated. When you’re divorced however, this is no longer possible. Instead such transfers to an ex-spouse result in the application of CGT on any notional (estimated) gain made by the transferor. 

During the divorce process, specific rules are applied to this transitional phase. 

In such cases you have until the end of the last tax year in which you lived together to transfer the assets and avoid a CGT charge. Furthermore rules are in place to stop you just living together having officially separated and continue to transfer assets tax-free. 

Transferring requires you to live cordially with the person you’re in a relationship with. If you have a deed of separation or a court order then this in effect means your split is permanent and in place. That puts paid to splitting up but continuing to live in the same house. You then have to arrive at a settlement and transfer your assets by the conclusion of the tax year. 

With regards to the family home, this is where things can get particularly difficult as the result of a tax change in place since April 2020. Often in cases of separation one of the divorcing couple will move out of the home. In terms of tax this used to not be an issue because legislation usually provided sufficient time to sell the property before being exposed to taxation on the uplift in the price. However, the sales period has been reduced to 9 months. Bearing in mind, the current market conditions quick sales are quite unusual.  

This exemption period applies only to a property that was the couple’s principal private residence (PPR). This tax relief was designed to enable taxpayers to sell their main home without having to pay CGT. To claim PPR, the property has to be your main residence 

If you sell your property after this 9 month window, it will not have been your main residence for the entire period of ownership, so you could be exposed to some CGT on the proceeds.  

Income Tax 

Spouses are taxed independently of each other on income they receive in the tax year and this continues during the period of separation and after Decree Absolute. Each spouse is usually entitled to an income tax personal allowance (£12,700 for 2020/21). The transfer of any assets under a divorce settlement is not in itself subject to income tax. However, if an individual is allocated income-generating assets like shares or interest-bearing cash bank accounts under a divorce settlement, they will be subject to tax on any income which subsequently arises on the assets they receive. 

Individuals are treated as no longer married for Income Tax purposes from the date of permanent separation. 

Inheritance Tax 

Transfers between spouses or civil partners are exempt from Inheritance Tax (IHT) and this remains the case throughout a period of separation and until Decree Absolute is pronounced. The exemption is limited to a lifetime total of £325,000 in total if a transfer is being made from a UK domiciled spouse to a non-domiciled spouse. There is no limit on the exemption for transfers from a non-UK domiciled spouse to a UK domiciled spouses nor where both spouses are non-domiciled. 

HMRC accept that transfers of property which take place after Decree Absolute, but are made under the terms of a court order in relation to the divorce proceedings, are exempt from IHT as long as there is no intention of conferring any gratuitous benefit on the recipient. Maintenance payments to a former spouse or civil partner are also exempt from IHT. 

Any other transfers between former spouses after Decree Absolute are treated as Potentially Exempt Transfers and, under current legislation, are exempt from IHT if the donor survives for 7 years following the date of gift. 

SRC-Time are one of the South East’s leading accountancy firms in advising businesses in all aspects of their accounting and tax affairs and we are able to assist in any issue raised above. 

Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at info@src-time.co.uk or speak with an account manager to get any process started. 

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