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Relationship Break-Up and Tax
Getting divorced is never a pleasant experience and couples going through the process have a lot to think about. Whilst management of the tax consequences of the split is not normally at the top of their priority list, these can be considerable, even where family income is fairly moderate.
For example, under the present rules one per cent of child benefit is added to the tax liability for every pound of income where income is in excess of £50,000. Where a couple have elected not to receive child benefit in order to avoid the charge, child benefit can be applied for again if the income level falls. It can be paid retrospectively for up to two years if the level of income would mean that there is no longer a clawback. Child benefit cannot be split, and the tax charge will be applied to the higher earner of the couple.
With tax credits, only one household can make a claim for any one child and a 'protective' application should be made if the split would make your income drop to the point at which you qualify for credits, as a claim can only be backdated one month. Under the new tax credit regime due to be introduced in 2017, maintenance received from a spouse will reduce entitlement to tax credits. Tax credits are unaffected by child benefit.
Older people can benefit from the extra Income Tax (IT) allowance known as the married couple's allowance, which is given if one spouse was born before 6 April 1935. It is given for the whole of a tax year in which a married couple have lived together. Where maintenance is paid in the circumstances in which one spouse was born before 6 April 1935, IT relief is given by way of a reduction in the tax payable from the year of separation. The reduction is a maximum of 10 per cent of the maintenance paid to a maximum of £3,040.
Income from jointly owned assets is taxable on the person beneficially entitled to it after the date of separation, so the presumption of an equal split of the income will no longer apply.
Capital taxes are also affected by divorce and separation. Most assets transferred post-separation are exempt from a charge to Capital Gains Tax (CGT) under the rule that exempts assets with a useful life not exceeding 50 years. However, post-separation transfers of assets will potentially be taxable after the end of the tax year in which separation takes place or, if a divorce is concluded within the tax year that separation takes place, after the divorce.
The main capital asset of a couple is usually the marital home. Although a couple who are not separated can have only one residence that qualifies for the CGT 'private residence' exemption, after separation each can qualify and, where the marital home is sold, the qualification period for the spouse that moves out of the property is extended for a further 18 months (this was 36 months until April 2014). However, where the property is transferred to the ex-spouse, no taxable gain arises, although if an election has been made for another property to be treated as the private residence, a taxable gain may arise on a transfer back to a former spouse.
Where a property is transferred into trust for children until they reach adulthood, it is normally possible to avoid a CGT charge arising on both the transfer into trust and the transfer from the trustees to the child or children.
Where there are business assets, a transfer can normally be made CGT-exempt through the use of 'gifts hold-over relief'.