The Christmas and New Year holiday period often provides time for reflection, celebration and the opportunity to focus on making positive changes, moving on and perhaps even a fresh start.
For some, this may mean engagements and wedding planning for 2022 and beyond. Equally this may also involve the decision to follow a solo path and dissolve a marriage or civil partnership.
In both circumstances, a change in legal status also generates a change in tax status. Whilst it may appear crass to leap from such significant life events to the what could be considered the sombre area oftax, it really is important to be aware of how marriage or civil partnership can affect an individual’s tax position.
A key example is Inheritance Tax, which is levied at 40% of the value of assets transferred on death, after deducting allowances. The effect of the current allowances is that many estates do not pay Inheritance Tax. However, the combination of a strong property market and frozen allowances means an increasing number of estates find themselves within the scope of Inheritance Tax.
The basic Inheritance Tax allowances available are:
- A Nil Rate Band allowance to transfer £325,000 of value to heirs free from IHT.
- A Residential allowance of £175,000 may be available where a home is closely inherited (defined in the legislation).
- A spousal exemption allows a tax-free transfer of assets to a surviving spouse or civil partner.
- Any allowances unused on first death are transferred to a surviving spouse or civil partner.
To compare the Inheritance Tax rules, consider the case of Annie and Ash, who jointly own a house worth £1 million with no mortgage. On Annie’s death, her Will directs that her share of the house passes to her partner Ash. On Ash’s death, his Will directs that the house passes to Xander, their son.
If Annie and Ash are partners but not married or in a civil partnership:
- When Annie dies, only £325,000 of her interest in the house can pass to Ash free of IHT, meaning there is an Inheritance Tax charge of £70,000. When Ash dies, £500,000 of Nil Rate Band and Residential allowances are available on the transfer to Xander. Assuming the house remains valued at £1 million, Xander has an additional Inheritance Tax charge of £200,000 when he inherits the property.
However, if Annie and Ash marry or enter a civil partnership:
- When Annie dies, her whole interest in the house can pass to Ash free of Inheritance Tax. When Ash dies, £1 million of value can pass to Xander against both Annie’s and Ash’s Nil Rate Band and Residential allowances.
The Capital Gains Tax (CGT) rules have a similar allowance for those who are married or in a civil partnership. Broadly speaking, spouses or civil partners who are living together can transfer assets between themselves free from CGT charges. However, where they are not married or in a civil partnership, the donor may be treated as if they have sold the asset at market value on the gift to their partner. If the asset has increased in value since they acquired it, a CGT charge may be levied.
Where a married couple or civil partnership separate, the position until now has been that the tax-free transfer rules apply for the remainder of the tax year of separation. In theory this provides some time to divide assets between the parties, without incurring CGT charges. In practice, this may not provide sufficient time to sort out the detail and decide who gets what.
The UK Government is currently consulting on this specific rule having recognised that the current timeframe may not be sufficient to allocate assets between separating parties. If recommendations are taken forwards, the tax-free transfer period may be extended to allow at least 2 years after the date of separation, which is a welcome relaxation in the rules.
Whether you have plans to get married or enter a civil partnership or you are separating, it is worth reviewing your tax position in relation to any shared or individual assets and ensure you seek the right professional advice to inform your decisions.
This article featured in The Scotsman on 17 January 2022.