Nothing is certain except death and taxes goes the quote. Despite this, many DIY divorcing couples often fail to appreciate the tax implications of a divorce and, more particularly, the movement of assets. A common misconception is that a married couple can deal with and dispose of their assets tax-free. Not so fast, as any passing tax officer would say.
By the way, this is a four-part series on DIY divorce, and tax is part four. You can read the rest of the series via the following links below.
Understanding tax consequences
At face value, a simple divorce with one property to sell or transfer will commonly be tax-free. There are, after all, tax benefits to being married. Complications creep in however if, for example, there is more than one owned property; if there has been a long absence by one spouse from the marital home following separation; if the structure of the asset base is complex (involving, say, businesses or pensions). Many couples do labour under the misapprehension that marriage is a shield against the tax consequences of splitting assets. Whilst marriage can be a mitigating factor to reduce a tax bill, it will not always eradicate a liability.
Understanding the tax consequences of a proposed financial division is important, as mistakes can be expensive. HMRC does not willingly wait for its money and penalties will accrue on unpaid tax bills. A wrongly timed divorce application in a tax year, for example, can lead to a tax bill that is otherwise avoidable. Ideally, a couple should give themselves the fullest tax year to try and conclude financial matters in an effort to maximise tax efficiencies. Divorce applications filed on 5 April are a no-no from a tax perspective, whereas applications filed on 6 April offer 12 months’ breathing space. Personal allowances should also be utilised with care. The timing of a divorce application can make the difference between whether one tax year’s personal allowance or two can be utilised. The realisation of taxable assets in a previous tax year is easily forgotten when a couple are still together, and a mistimed divorce application can limit the benefits of a personal allowance the following year.
Tax consequences for separated couples
Another common but overlooked tax problem is where a separated couple live. If two properties are owned, it is not uncommon for there to be a period of separation during which one spouse lives in one property and one departs to the other property. A sensible and practical solution, but the departed spouse is potentially starting to incur a capital gains tax liability. If, at the same time, the second home has been owned for a number of years and has gone up significantly in value, the capital gain grows ever bigger making the pain on disposal for the couple ever greater. I once had a client who, when unexpectedly faced with a huge tax liability in just this scenario, quietly reconciled with his wife after years of separation. He swore it was not for tax reasons, but a cynical tax officer may beg to differ.
Fortunately, the government has recently announced improved tax consequences for separating couples. These are expected to come into effect in April 2023 and give a separating couple more time to finalise their financial arrangements before tax liabilities bite. They do not offer relief or mitigation in every scenario and so tailored tax and legal advice shortly after separation remains critically important. This enables tax-efficient planning and ultimately keeps more money in the marital pot to share between a couple.
