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Considering the Potential Tax Implications of Divorce

December 2021

If you are separating from your partner, it is important to consider the tax implications of a divorce.

If you are domiciled in England and Wales and choose to process your divorce in this jurisdiction, both parties may find significant differences to the ways in which they pay tax. We outline below some of the key taxes and tax benefits that can be affected when you divorce.

Income Tax

When it comes to Income Tax, everyone is taxed as an individual. However, there are certain rules which can aid in reducing a couple’s Income Tax liability. Married couples can apply for a Married Couple’s Allowance; this enables a spouse with a low income to transfer 10% of their personal allowance to their higher-income spouse if neither is a higher rate taxpayer (i.e. neither has an income above £50,000).

As the name would suggest, this is only available to married couples living together, therefore upon separation or divorce, the couple will lose this tax benefit.

Inheritance Tax (IHT)

While married, transfers of funds between spouses are exempt from Inheritance Tax (IHT); this is known as the spousal exemption. However, issues can arise if one spouse is not domiciled in the UK.

Once parties are legally divorced, any transfers could be considered Potentially Exempt Transfers (PETs). However, these exemptions only apply if the transferrer lives for longer than seven years after making the transfer. If the transferrer dies within seven years of the transfer, IHT will need to be paid but a tapering relief is applied so the tax payable is reduced each year.

Capital Gains Tax (CGT)

When an asset is sold in England and Wales the gain made on the asset is taxable. This is known as Capital Gains Tax (CGT). Whilst transfers of assets between spouses are generally not subject to CGT, this changes when the couple separates.

When a couple separate this rule continues to apply only until the end of the tax year. Therefore, the date of separation is crucial when transferring assets as this can give rise to a CGT liability. The tax payable on CGT is charged at either 18% or 28% however it is possible that an exemption applies.

In most circumstances the main asset will be the family home or the former matrimonial home (FMH). If the FMH is sold, Principal Private Residence Relief (PPR) will be available. However, if you or your spouse vacate the FMH while the other remains, this can cause difficulties. This is because the PPR may not apply in full to the departing spouse’s share. If either of you has left the FHM for long than nine months, the FHM will not be considered your primary home and therefore falls outside of the remit of the PPR.

You should also be aware that the regulations around CGT payment changed as of 6 April 2020. Please seek legal advice from a Private Wealth lawyer if you have any questions in relation to this.

Stamp Duty Land Tax (SDLT)

Stamp Duty Land Tax (SDLT) is the tax on land transactions in England and Northern Ireland. SDLT is paid by the person purchasing the land and is payable within 14 days of the transfer of a property.

It is important to note that if the transaction relates to a divorce or has been made pursuant to a court order, the transaction is exempt from SDLT. However, if one spouse intends to purchase another property while remaining the legal owner of the FMH, they may be subject to SDLT.

It is important to consider the potential tax implications of divorce and how they could potentially impact your finances. An experienced Family lawyer will be able to guide you through the relevant tax implications and prepare you for every situation. However, if you are ever in doubt about an issue, do not be afraid to ask.