Tax Implications of Separation and Divorce

  • Insight

11 May 2021

When a marriage or civil partnership breaks down the last thing on your mind is the effect that the break-up might have on your relationship with the tax man. However if you don’t factor tax in at the outset, you could be in for a nasty surprise.

There are a number of considerations that you should discuss with your family law adviser, who can in turn refer you to a tax specialist:

1. Transferring assets between separating spouses

Capital Gains Tax (CGT) is payable when you make a profit or gain on an asset you sell or give away over and above your tax free exemption. However CGT does not apply on transfers between spouses or civil partners and will continue to apply during the tax year of the separation and any transfer will need to be completed within that same year to avoid potential CGT liabilities.

2. Transfer or sale of the family home

Tax relief applies where the family home is your Principal Private Residence (PPR) so that there may be no CGT payable on any gain. Where one spouse moves out, the relief will continue for an allowed period so long as another property has not been elected as your PPR. It is important to keep an eye on this period of absence. In general, the period of PPR relief will only now apply for 9 months since occupation (18 months for disposals prior to 6 April 2020). This period can, however, be extended provided certain conditions are satisfied.

3. Family businesses

The tax exemption for transfers between spouses in the tax year of separation also applies to assets held within a family partnership or shares in a family company.  Where the Agreement or order by the court transferring the partnership asset or company shares is dated after the tax year of separation, it may be possible to defer the tax to be paid by applying for “hold-over relief” if certain qualifying criteria are met. If a partnership operates between a husband and wife who separate, it is not unusual that the partnership will be dissolved or will continue in the name of one spouse only, sometimes with a new partner.  This could lead to tax issues depending on how the underlying partnership assets are held.  Where funds are to be withdrawn from a capital account, income tax will be payable on the profits taxable in the year of cessation of the partnership.

4. Tax exemptions on death of separating spouses

As well as losing the exemption for CGT on separation, spouses will also lose their exemption on inheritance tax (IHT) charges which would not apply when they were married.  The IHT exemption will only apply up to the date of divorce.  Transfers between spouses will continue to be exempt from a charge to IHT where the transfers are not intended to be made in return for something or where the transfer is made for maintenance of the family.

5. Income tax and tax credits

Separating spouses have a duty to support one another financially by paying aliment until they are divorced.  Sometimes this payment will continue after divorce where it is ordered by the court or as part of an agreement.  The spouse making the payment of aliment from income will be taxed on their gross income from the initial payment received.  Maintenance payments received are not subject to income tax by the spouse receiving the payment. Tax credits for children should be claimed by the spouse with whom the children live.  This can be unclear where there is a shared care arrangement between parents.  However as the test for tax credits is now means tested, it is expected that it is the spouse who would qualify for the credits that would claim where the children are living with each parent on a shared basis.

 

To avoid a situation where the tax issues on separation or divorce become taxing, or are overlooked, it is always worthwhile seeking sound advice from a family law solicitor who can direct you to the appropriate tax expert.  Where there is a family business some careful consideration should be given as to how the business will be maintained in the future and plans made accordingly bearing in mind the tax consequences.

Tax paid on transfer or sale of the family home

The tax consequences of separation differ when it comes to the family home.  Where the family home is your only or main residence, throughout your period of ownership you will be entitled to a full relief from CGT on any gain.  This is known as Principal Private Residence (“PPR”) relief.  For separating couples the PPR of both spouses is likely to be the same property when they separate.  However, this might change where one spouse moves out of the family home and buys a new property. 

The relief to CGT will continue to apply for an allowed period of absence from the property and so long as another property has not become or been elected as your PPR. 

It is important to keep an eye on the period of absence from the PPR.  The period of PPR relief will apply for three years since occupation providing certain conditions have been satisfied . This period of relief is set to be shortened to eighteen months with effect from 6 April 2014. 

This period of relief can be extended by HMRC where the interest in the house is eventually transferred to a spouse who has continued to occupy the primary residence as part of an agreement on how the matrimonial assets should be divided. 

Separate from CGT, there is an exemption on Stamp Duty Land Tax (“SDLT”) on transfers of any property agreed by parties in contemplation of or in connection with divorce.  It is therefore not expected that SDLT will be payable where a property is to be transferred between spouses.  The SDLT exemption could also apply to transfers to children in contemplation of divorce where a decision has been made to retain a property for the future good of the family.

Tax considerations for family businesses on divorce

There are also tax considerations where spouses hold an interest in a family business.   The tax exemption for transfers between spouses in the tax year of separation also applies to assets held within a family partnership.  Where the Agreement or order by the court transferring the partnership asset or indeed company shares is dated after the tax year of separation, it may be possible to defer the tax to be paid by applying for “hold-over relief” if certain qualifying criteria are met.

If a partnership operates between a husband and wife who separate, it is not unusual that the partnership will be dissolved or will continue in the name of one spouse only, with a new partner.  This could lead to tax issues depending on how the underlying partnership assets are held.  Where funds are to be withdrawn from a capital account, income tax will be payable on the profits taxable in the year of cessation of the partnership.

Tax exemptions on death for separating spouses

As well as losing the exemption for CGT on separation, spouses will also lose their exemption on inheritance tax charges which would not apply when they were married.  The inheritance tax exemption will only apply up to the date of divorce.  Transfers between spouses will continue to be exempt from a charge to inheritance tax where the transfers are not intended to be made in return for something or where the transfer is made for maintenance of the family.

Income tax and tax credits for separating couples

Income tax does not automatically cause problems for separating couples as individuals are taxed on their own income.  Separating spouses have a duty to support one another financially by paying aliment until they are divorced.  Sometimes this payment will continue after divorce where it is ordered by the court or as part of an agreement.  The spouse making the payment of aliment from income will be taxed on their gross income from the initial payment received.  Maintenance payments received are not subject to income tax by the spouse receiving the payment.

When it comes to tax credits for children, these should be claimed by the spouse with whom the children live.  This can be unclear where there is a shared care arrangement between parents.  However as the test for tax credits is now means tested, it is expected that it is the spouse who would qualify for the credits that would claim where the children are living with each parent on a shared basis.

To avoid a situation where the tax issues on separation or divorce become taxing, or are overlooked, it is worthwhile seeking sound advice from a family law solicitor who can direct you to the appropriate tax expert.  Where there is a family business some careful consideration should be given as to how the business will be maintained in the future and plans made accordingly bearing in mind the tax consequences.

If you have a query regarding any of the above, please contact