If you and your spouse are getting divorced, you might not realise how splitting up could affect your taxes. Nevertheless, the tax implications of ending a marriage can be significant. By following good tax advice, you can prevent your finances, which are already under pressure, from taking yet another hit. Learn how different kinds of taxes are affected during a divorce or separation in the UK so you can take steps to avoid overpaying.

What Happens to Inheritance Tax During a Divorce?

Inheritance tax (IHT) is levied on a person’s estate when they die, along with certain gifts they make during their lifetime. Most gifts made more than seven years before death will escape this tax.

In most situations, the IHT implications on divorce are limited, not least because IHT will not typically arise until there is a death. Any assets transferred between couples from the period of separation until the decree absolute are included in the spouse exemption. Even if assets are transferred after the divorce, they are likely to escape an IHT charge because the court assumes they are not “transfers of value” to confer gratuitous benefit. Rather, they occur because of a court order or compromise between the parties as part of the divorce proceedings. If a transfer is likely to be construed as a gift, you should seek legal advice specific to your situation.

The risk of inheritance tax on divorce arises when an ongoing trust is created, including a deferred trust of land, under a Mesher or Martin order. This holds the property in both spouses’ names on trust until a specified event occurs, such as the youngest child turning 18 or leaving education. Until then, the occupying spouse has the right to reside in the property. A deferred trust of land should have no immediate adverse effects from an IHT perspective because, as above, transfers as a result of a financial settlement order is not a ‘gift’ for IHT. However, if the trust is created after the decree absolute or dissolution order, you may be at risk of future inheritance tax liability. In addition, where someone is likely to have an estate where IHT is charged, it can be beneficial to seek some planning advice before the property vests back in them for IHT, usually when the specified event occurs under the Order.

There is also a chance of IHT charges when one spouse lives in the UK, and the other does not. The inheritance tax exemption limit for the 2022/23 tax year is £325,000 for gifts between spouses when the receiving spouse is domiciled outside the UK, this sum is separate and additional to the Nil Rate Band. Any sum transferred above this amount is potentially exempt from IHT, provided the transferring spouse survives for seven years following the transfer.

What Happens to Income Tax During a Divorce?

Since married couples are taxed independently on their income, divorce shouldn’t greatly impact each person’s income tax liability. However, there may be tax implications for transferring income-producing assets as part of the divorce settlement.

Divorcing couples should also know that spousal support payments are generally not taxable on the recipient. At the same time, they are not tax-relievable for the payer.

What Happens to Stamp Duty Land Tax During a Divorce?

Stamp Duty Land Tax (SDLT), also known simply as Stamp Duty, is payable by the purchaser on land transactions, including buying a house or flat and creating or assigning a lease.

Transactions of this nature in direct connection with a couple separating, divorcing or dissolving a civil partnership are generally exempt from SDLT. This includes the transfer of the family home between spouses. However, if the spouse who moves out of the family home buys a new property, they will owe Stamp Duty.

Under normal circumstances, buying a property whilst retaining an interest in another would give rise to an additional Stamp Duty Land Tax of 3 per cent of the property’s value. This amount would be payable in addition to the standard SDLT rates. However, in divorce cases, the spouse with an interest in the family home is not subject to the additional SDLT charge when buying a new residence, provided the family home remains the other spouse’s primary residence.

What Happens to Capital Gains Tax During a Divorce?

The most significant tax implications during a separation or divorce are those related to the Capital Gains Tax (CGT). This is the tax on profits realised on the sale or transfer of a non-inventory asset. Since valuable assets—including the family home and any secondary homes or investments—are likely to transfer from one spouse to another as part of the divorce settlement, couples should prepare to have CGT liability.

Getting the timing right is the key to avoiding Capital Gains Tax on divorce. For instance, transfers during a tax year in which the couple have lived together at some point occur on the basis of “no gain, no loss.” This means the receiving spouse obtains the asset for the value at which the transferring spouse acquired it. Therefore, no Capital Gains Tax applies. Note that spouses or civil partners are considered “living together” unless they are separated under a court order, by deed of separation or where the separation is likely to be permanent.

However, transfers in a tax year after the couple have formally separated occur at market value. Therefore, any gain is taxable on the transferring spouse. For this reason, it’s usually preferable to transfer assets in a tax year in which the couple have lived together to minimise taxes and maximise the pool of funds available to be shared by each spouse.

What Happens to My Home During a Divorce?

In general, gains on the family home for a divorcing couple where the property has been their main residence are exempt from Capital Gains Tax when the home transfers from one spouse to the other. However, when one spouse moves out and buys or rents a new property, their main residence changes.

In this case, Principal Private Residence Relief (PPR) may be available to exempt any value gain on the family home. For PPR to apply in full, any sale or transfer of the property must occur within 9 months of the date of separation when the transferring spouse moved out. (Note that before April 2020, this period was 18 months.)

This 9 month period can be extended indefinitely under a number of different circumstances but, most notably, where the property is transferred under a court Order in the divorce proceedings.

The period of absence can be extended indefinitely if the following conditions are met:

• The property is left to the former spouse as part of the divorce settlement.
• The transfer is made in connection with the permanent separation, divorce or dissolution of the relationship or under a court order.
• The dwelling continues to be the main residence of the receiving spouse from the date of separation until the transfer or sale of the property.
• The transferring spouse elects not to have another property be their main residence for any part of this period.

Do I Have to Change My Will During a Divorce?

When a couple gets divorced in the UK, any Wills the former spouses may have are not automatically revoked when the Final Order is granted and its validity is unaffected by a court Order. However, for inheritance purposes, the ex-spouse is treated as if they have died when the marriage dissolves. The important point to note is that this only occurs with the Final Order which may not be received until many months into the process.

This can seriously affect your estate. For instance, if you don’t update your Will to reflect your impending divorce, your Will may leave everything to your spouse – that may very well be the opposite of your intention

Additionally, the rules of intestacy could apply to your estate after the Final Order if the removal of the spouse from your Will would leave some of your assets without a beneficiary. This means your property and assets could end up divided differently than you intended upon your death, jeopardising any inheritance you planned for specific family members or a new spouse you may marry later on.

A point that is often overlooked with Wills and divorce is that, where there are children, they will rarely have a Will in place whilst they are younger. If the result of the Final Order would be to benefit your children instead of your former spouse, could that mean your money might still end up with your former spouse whilst they are in a position to control the children? Similarly, if something happened to a child before they have a Will in place it may then all end up with your former spouse under the rules of intestacy again. For many divorcing couples, these are important points to consider.

For these reasons, divorcing couples should seek estate and tax planning advice to update their Wills and other related financial documents once the divorce is finalised. The goal is to reflect the new marital status in the Will and make this document as tax-effective as possible.

Get Help Navigating Tax Implications on Divorce

As a family law expert with multiple offices in the UK, Parfitt Cresswell is well-qualified to guide you through the divorce process. We’ll help you make wise financial decisions regarding your taxes, the family home, wills, trusts and other aspects of your life affected by getting divorced. To schedule your free, no-obligation consultation with an experienced lawyer, please contact a Parfitt Cresswell office near you today.