For richer or for poorer? Marriage and Tax
Wedding season is in full swing, with couples across the country gathering friends and family together to witness them tie the knot. With marriage figures rising once again (the Office of National Statistics reported a 3.7% increase in 2010) there are clearly enduring reasons why people choose to commit to each other ‘for better or worse, for richer or poorer, in sickness and in health’.
It’s well documented that marriage is linked to longevity, improved health and wellbeing, but did you know that it can make sound financial sense too? While the government has yet to introduce their mooted tax break for married couples, there are still cogent reasons why getting hitched can bring significant tax savings – provided you stick to your vows and play by the rules.
The tax system does not explicitly recognise marriage or civil partnerships. The married couples allowance was abolished on 6thApril 2000, eliminating anyone born before 6 April 1935, and was replaced with children’s tax credits, ostensibly levelling the playing field for cohabiting couples. For income tax purposes married individuals are treated separately, offering no obvious benefit. Nevertheless, there are significant tax advantages to marriage - by distributing income and assets between them and using up all personal allowances, married couples can pay tax at the lowest possible marginal rate and considerably cut their tax bill.
The two most obvious tax benefits for a married couple or civil partners relate to capital gains tax (CGT) and inheritance tax (IHT). As a married couple, you can transfer capital assets (say, shares or a second property) between spouses without having to pay CGT. If capital gains exceed the annual CGT exemption, spouses and civil partners can substantially reduce their tax bill by transferring the ownership of the asset to the spouse who pays tax at a lower rate.
Significant savings can be made on Inheritance Tax (IHT). If you are married and your partner dies, you will not have to pay IHT on the inheritance no matter how big the estate. In addition, your spouse’s nil rate band (the amount you are entitled to inherit before IHT must be paid) will transfer over to you, doubling your nil rate band from £325,000 to £650,000. This means that when you die, your children will not have to pay IHT on anything under the £650,000 cut-off point. If you are co-habiting rather than married, you will be exempt from this benefit.
Being a married couple also offers notable business benefits. A commonly used tax strategy is to introduce a spouse into the business either as a partner or by splitting the shareholdings in a family company.
Due to ‘spousal exemption’ it’s possible for one spouse, who may be actively involved and running the company (the settlor), to gift shares (and the resulting rights) to a spouse who does not draw a salary from the business, or necessarily have any active involvement.
For a higher-rate taxpayer (HRT), it is well worth considering how net income can be maximised by splitting the shareholding and consequently the sharing of dividend payments with their spouse. By drawing a minimum salary, the settlor can thereby maximise corporate profit and potential dividend payments. As long as their spouse is earning below the HRT threshold, it’s possible to take advantage of their unused personal allowance and basic rate band and therefore pay lower-rate tax on a substantial proportion of the income from the business.
As HMRC has had a beady eye on the activities of businesses where one spouse is much more involved than the other – for example in the much publicised case of Arctic Systems LTD in which HMRC attempted (and failed) to tax Geoff Jones on dividends paid to his wife – it’s worth being aware of the pitfalls before considering making a spouse a partner or shareholder.
It’s likely that the impending General Anti-Abuse Rule (GAAR) will only harden HMRC’s attitude, bringing many long-established tax-planning practices under the microscope to examine how ‘reasonable’ they are.
While HMRC currently accepts that ‘a partnership is not a sham merely because one of the benefits is a tax saving’, HMRC is nevertheless becoming more interested as to whether the less involved partner/shareholder has an active involvement in the affairs of the business. To ensure the arrangement is watertight, all shares should be ‘ordinary’ with full voting rights. The strongest position, however, is where both husband and wife are shareholders from the genesis of the company. It also helps if both spouses receive equal dividends and that as far as possible the ‘non-earning spouse’ is involved in the key aspects and decision-making process of the business.
A final word of advice – ‘spousal exemption’ and all of its resultant potential benefits in terms of minimising tax liability for married couples only applies if you continue to live together – and are not separated in circumstances likely to lead to a divorce. A tax year of separation will be your final opportunity to take advantage of the spousal exemptions available, as these cease in the year following this year of separation. All future transactions are deemed to take place at market value. So yet another reason – if the pursuit of conjugal felicity were not enough - to stick to your promise ‘till death do us part’…
Mike Fleming is Tax Director at Straughans Chartered Accountants www.straughans.co.uk
This was posted in Bdaily's Members' News section by Mike Fleming CTA. TEP. .
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