Nevertheless, as Valentine’s Day is approaching, I thought it would be appropriate to outline some of the advantages that married couples enjoy for tax purposes. Everything in this article also applies to Civil Partnerships, by the way.
Independent Taxation
The first thing to remember is that a married couple is taxed entirely separately, as two distinct individuals. This was not always the case. When I began my career in tax, the husband was taxed on his wife’s income as well as his own.
There were various allowances and reliefs, and some scope for confidentiality, but I still recall interviewing a small trader whose wife had significant bank deposits whose interest was missing from their joint tax return. He claimed to have no knowledge of this income, and said I should meet his wife. When he brought her in to see me, I immediately accepted his plea of ignorance, and feeling it was not my place to add to his troubles, I closed the case down.
Since 1990/91, however, this system has been replaced with independent taxation, and it is from this that a number of tax planning opportunities flow.
Income Tax
Each husband and each wife has their own personal allowances and their own tax bands, so a married couple can have a joint income of about £82,000 before they start to pay income tax at the 40% rate, assuming they “equalise” their income so that it is split evenly between them.
This is easiest to do in the case of those who run a business together as a partnership or a limited company, or those who live entirely on investment income, but in any case where only one spouse is paying 40% tax it is worth looking at the situation to see if some of the higher rate spouse’s income can be transferred to the lower rate one.
This can be quite simple – in the case of a buy to let property, for example, the lower rate spouse can be given a larger share of the equity so that they are taxable on more (or all) of the rental income. There are, however, a couple of pitfalls to avoid:
· Although as we shall see no capital gains tax arises on a transfer between spouses, they are deemed to share the income from jointly owned property equally unless they both sign a “Form 17” and send it to HMRC, electing to be taxed on their actual beneficial share of the income. The same rule applies to other joint investments, with the exception of shares.
· Stamp Duty Land Tax is not charged on a gift of property, but if there is a mortgage attached to it, the recipient of the gift is deemed to have “paid for the gift by taking over responsibility for the same proportion of the mortgage as the gifted share of the property”. This is only a problem if the value involved is above the SDLT threshold (currently £175,000 for residential property).
Last year there was quite a fuss about “income shifting”, meaning engineering things so that the profits from the family business were divided between spouses in the most tax efficient manner. This arose as a result of HMRC losing an important case before the House of Lords, where they had tried to impose their own view of a proper split of profits on a company owned by a husband and wife – the famous “Arctic Systems” case.
Few issues could have highlighted more dramatically this government’s distaste for small businesses, because the measures they proposed to counter “income shifting” would only have applied to partnerships and family companies, not to a millionaire who chose to give his wife a block of flats to use up her lower rates of tax, nor to the director of a listed company (for example, one of the High Street Banks) who gave his wife some of his shares.
One of the few good things to come out of the credit crunch is that this proposed legislation has been kicked into touch for the time being, and we have an undertaking that it will not form part of the 2009 Budget.
For the time being, then, it makes tax sense to ensure that income is “shifted” so that each spouse uses all of their lower rate tax band.
Capital Gains Tax
Transfers between spouses take place at “no gain and no loss”, whatever the amount (if any) that is actually paid by the spouse acquiring the asset.
When selling an asset that is likely to realise a substantial gain, therefore, it can be helpful to transfer a share to the spouse before the sale in order to use up their annual exemption from CGT. This is currently £9,600, so, with CGT at 18%, a saving of up to £1,728 can be made (£9,600 x 18%).
There is also scope for transferring an asset to take advantage of losses that the other spouse has incurred in the same or a previous tax year, though some caution is needed here because of the “Targeted Anti-Avoidance Rule” or TAAR introduced in December 2006. Essentially, this is directed at artificial use of losses to avoid CGT, but it can catch innocent transactions and anyone planning something involving their spouse’s CGT losses should take advice to ensure they will not fall foul of it.
Another point to watch is Entrepreneur’s Relief, which applies to the disposal of shares in a family trading company or the sale of a family business. If you qualify for this and your spouse does not, then a gift of part of the business before sale may mean that ER is lost on that part gifted, so that instead of you paying 10% CGT, your spouse pays 18% - again, advice is needed.
Inheritance Tax
The scope for married couples to reduce tax is perhaps greater here than anywhere else. A legacy from one spouse to another is free of IHT, and if the first spouse to die leaves everything to the survivor, even greater savings can be made, because the “nil rate band” of the first spouse passes to the survivor.
The “nil rate band” for IHT is the amount of your estate that is charged to tax at 0%, and it is currently £312,000. If the first spouse to die left everything to the survivor, so that his (statistically, it will be “his” not “her”) nil rate band is not used, then this can be added to her nil rate band when she dies, giving a total of £624,000 not charged to IHT.
It should be noted that this rule applies even if the first spouse died years ago – it applies to the death of a second spouse after 9 October 2007.
Marry for Tax Reasons?
Despite my wife’s taking offence at my casual remark, it is nevertheless the case that marriage offers certain benefits from a tax point of view, and I must confess that on two occasions in my career I have specifically advised couples who were living together on a long term basis that they really could save a lot of money by marrying – in one case involving an elderly couple, as soon as possible!
So, enjoy that Valentine’s Day dinner, and if you are not married to your dinner companion (or to anyone else, of course), you might just like to pop the question:
“Darling, we’ve been so happy together these past few years, I wonder if you would consider doing me the honour of joining me in some serious tax planning....”
James Bailey
