Divorce: Some Tax Issues To Note

Malcolm Finney looks at tax issues often overlooked.

According to the Office for National Statistics, the estimated percentage of marriages ending in divorce is around 42%, nearly one-half of all marriages. At the time of divorce it is probably fair to say that, the very wealthy apart, taxation issues are not usually at the forefront of either spouse’s mind. However, whilst understandable, a little thought and advice may often reduce tax liabilities quite significantly.

Income tax, capital gains tax and inheritance tax consequences are all of relevance although perhaps capital gains tax is potentially the most significant. 

For most married couples, their matrimonial home is their most important and most valuable asset. Fortunately, where the marital home is sold any capital gain arising is often simply exempt from any capital gains tax charge. However, any gains arising on buy to lets will fall subject to capital gains tax on any sale.

Where one spouse moves out of the family home whilst the other spouse (normally plus children) remains living in the home any gain arising on eventual sale will be liable to capital gains tax on some part of the gain attributable to the departing spouse if the sale occurs after 18 months from the date of departing the home. However, if the departing spouse is required (under the divorce) to transfer his interest in the home to the spouse remaining in the home any capital gains tax charge on any gain arising on such a transfer may be avoided (subject to satisfaction of certain conditions) even if the transfer occurs more than 18 months after departure.

The capital gains tax consequences, however, become more complicated where one spouse moves out and the other spouse (normally with children) is allowed to remain living in the home until, for example, the children reach age 18 at which time the home is to be sold and sale proceeds split. In such cases, the courts have adopted one of two options, namely, the issue of a so-called ‘Mesher’ order or a deferred charge order (each giving rise to different capital gains tax consequences). 

Main home apart, any valuable assets to be transferred between spouses (eg expensive jewellery; antique tables/paintings etc) should be done whilst the married couple is still living together (ie prior to the end of the tax year of separation) as no capital gains tax charges arise on such inter-spouse transfers. After the end of the tax year of separation, any such transfers no longer qualify as exempt inter-spouse transfers and are treated as taking place at market value typically giving rise to capital gains tax charges.

The date of any asset disposal for capital gains tax will be the date of any relevant contract or the date of the actual transfer if by delivery. However, a transfer pursuant to a court order takes place at the date of the order or, if later, the date of the decree absolute.

For the tax year 2018-19 any individual is entitled to an annual exempt amount of £11,700 with any excess gain subject to rates of 10% and/or 20% (or 18% and/or 28% for residential properties) depending upon whether the individual has exhausted his/her basic rate band.

Inter-spouse transfers where the spouses are both married and living together (i.e. not separated) give rise to no capital gains tax charge whereas to qualify for exemption from any inheritance tax charge requires only that the spouses are married (not necessarily living together). Thus, even transfers post separation but pre the decree absolute attracts no inheritance tax charge without limit (unless the transferor spouse is UK domiciled and the transferee spouse is non-UK domiciled; in which case the exemption is limited to transfers up to an aggregate of £325,000 albeit with a nil rate band of £325,000 in addition).

Furthermore, even transfers between ex-spouses after the decree absolute are normally possible without giving rise to any inheritance tax charge and the related property provisions are (helpfully) no longer in point.

There are virtually no income tax consequences on divorce following the abolition of income tax relief on maintenance payments for the payor (the payee receiving such payments tax-free). 

It may perhaps be worth noting that with respect to jointly held property (e.g. a buy to let) any rental income arising will be subject to income tax according to the beneficial percentages held in the property (i.e. rental income will not be split 50/50 as may have been the case during marriage).

Divorce (unlike marriage) does not cause a will to be revoked although gifts to the former spouse made under the will lapse.

In many cases, each spouse often leaves the bulk of his/her estate to the other surviving spouse so as to mitigate inheritance tax on the first death. Once divorced, this option will no longer be available and the will needs to be urgently revisited.

For the spouse contemplating divorce, early tax advice and a little planning could save both spouses a not insignificant amount of tax. In addition, the terms of any will need to be revisited.