Yahoo Finance Tax hacks: how to keep your money after divorce
Separation and divorce are so stressful it is unsurprising that few consider the tax implications at the time it happens.Nevertheless, with about 42pc of marriages and civil partnerships failing it is worth keeping in mind a few key tax planning points.
After all, finances are likely to be stretched and there is no point adding to the burden with an avoidable tax bill.
The key point to appreciate is that the normal rule allowing tax-free transfers of assets between spouses ceases for capital gains tax (CGT) purposes at the end of the tax year in which the separation has become permanent.
I understand that the peak demand for divorce lawyers is the first working Monday after the Christmas break, something to do with office parties, booze, and relatives. However, couples would be better to wait until 6 April before separating on a permanent basis so that there is more time to sort out their finances free of CGT issues.
In the past it was common practice to make maintenance payments but these are no longer particularly tax efficient. Where circumstances permit it is usually better to have a separation of assets so that both parties generate income independently.
This also helps to achieve the clean break that many want. For example, if one spouse is working and the other spouse cares for the children and has no employment, it may make sense to transfer some shares, unit trusts or investment properties to them before the tax year end as the whole or part of any financial settlement. All of these transfers could trigger a CGT liability based on their market value if they happened after the tax year of separation.
The biggest asset is likely to be the family home. In normal circumstances no CGT would arise on a sale or transfer because of the principal private residence relief (PPR). This relief would typically still apply, but not indefinitely. Once one spouse has moved out it can cease to be treated as their PPR.
In practice this will not be a problem if any transfer of the whole or part of the property takes place within 18 months, but after that a portion of the capital gain could start to lose the exemption and is potentially subject to tax. Given the rise in property values this could rapidly become a serious issue.
In addition, this 18-month period is set to reduce to nine months from next April.
Fortunately the rules allow this period to be extended for transfers between spouses as long as one spouse continues to live in the property and the spouse leaving the property has not acquired another home which has become their PPR.
This can raise another interesting issue because in these circumstances either home could be treated as the PPR for the spouse who has moved out but they can make an election for which property should be treated as their main home for tax purposes. This election has to be made within two years of buying their new home.
With one in 10 households now having a second property, as a holiday home or buy to let investment, that will often become the new home of the spouse leaving the main home. In that case more complicated tax issues arise on which advice should ideally be sought.
For inheritance tax (IHT) purposes it is not the separation that is important but the date of the Decree Absolute. Prior to this, assets transferred between spouses are exempt from IHT. After that date, unless the transfer is being made under a court order, the normal rules apply and a transfer of assets could potentially be caught for tax.
In practice this may not be an issue due to the normal lifetime gifts rule and the current £325,000 tax-free band but this risk should not be ignored.
The second most valuable asset in a marriage is often accumulated pension benefits. Today there is far more flexibility available for pension splitting. Depending on the rules of the pension fund it should be possible to arrange a full split of the pension benefits under pension sharing.
This gives a clean break in the arrangements and leaves each party with their own pension income in retirement along with the associated tax benefits of utilising separate personal allowances and basic rate tax bands. With personal pension schemes this should be relatively straightforward but it can also apply with final salary schemes if handled correctly.
Finally, having deliberately concentrated on the tax issues, I should make the obvious point that with the many other issues to be considered you would be well advised to take good legal advice.
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