Are divorce settlements taxable? – Ian Walker
Are divorce settlements taxable?
The tax treatment of divorce settlements is something that concerns many people who are going through divorce. However, as we will see, in most cases there is only really one tax issue that should be of concern.
Before we get to that, let us very quickly consider some other tax issues that can arise.
(Please note that tax implications of a divorce settlement can be quite complex. This article is intended to be no more than a brief, and simplified, outline of some of the most important points.)
We cannot give financial advice – but in order to do the best for our clients it is important to bear tax issues in mind and for the best advice to be sought from tax specialists as needed.
The recipient of maintenance payments does not have to pay tax on the payments.
By the same token, the payer of the maintenance cannot usually claim tax relief on the payments. The exception to this applies only if (amongst other things) the payer or the recipient were born before the 6th of April 1935.
This is a tax on the estate of someone who has died. The tax is payable on the value of the estate above a certain threshold (currently £325,000). However, there is normally no tax to pay if the estate passes to the spouse of the deceased.
Obviously, once a divorce goes through this ‘spouse exemption’ no longer applies. However, transfers that are made after the divorce under the terms of a court order do not normally attract inheritance tax.
Many couples nowadays own foreign assets, which will need to be dealt with as part of the divorce settlement. Obviously, this may have local tax implications in the country where the asset is located, and those implications must therefore be considered before the settlement is finalised.
Capital Gains Tax
This is the main tax issue that is likely to concern anyone contemplating entering into a divorce settlement.
Capital Gains Tax is payable on the profit when an asset is disposed of (i.e. the amount by which the asset increased in value over its original purchase price). In the divorce context, the disposal may be a sale of the asset, or a transfer of the asset from one spouse to the other.
If the spouses are living together, any transfer of an asset from one to the other is treated as giving rise to neither a gain nor a loss to the person transferring it, so no capital gains tax is payable. Spouses are treated as living together unless they are separated under a court order, by a formal Deed of Separation, or in such circumstances that the separation is likely to be permanent.
Spouses are still treated as living together for the remainder of the tax year in which they separated, but transfers after that may attract capital gains tax. It can therefore be important when you and your spouse separate.
Another factor to be taken into account is that capital gains tax is not normally payable on any gain arising from the disposal of a person’s private residence. However, two spouses cannot have more than one residence for the purpose of this relief at any time while they are living together.
This can lead to problems when a spouse who has vacated the property transfers their interest in it to the other spouse, as part of a divorce settlement. If the transfer takes place more than a certain period after the transferring spouse left the property, then the full relief will not be due.
Divorce settlements can involve the transfer or sale of business assets. Such transactions may also have Capital Gains Tax implications. There are a number of rules relating to this, but they are too complicated to be dealt with in this article.
Obviously, it is essential that you know the tax implications, if any, of any proposed divorce settlement.
We are specialist solicitors and mediators. We are not regulated to give financial advice. However as you will see it is important to bear tax implications into account whilst negotiating any financial settlement.
For this reason we work with accountants and financial planners who specialise in tax matters and we are also happy to work with your existing financial advisers. These issues can be important – and it is therefore fundamental that the best advice is accessed before any final settlement is agreed.
To find out more, and to get started with one of our specialist lawyers, click here.