Essential tax and financial planning strategies for married couples

Learning Objectives

• To understand the opportunities that exist for tax-efficient distribution of income between married couples/civil partners;
• To learn about how capital gains tax operates for married couples and civil partners and how ‘no gain/no loss’ treatment can be used to make tax savings;
• To recap on the inheritance tax treatment of spouses and civil partners so that opportunities to maximise reliefs and allowances are not missed

According to the most recent Census, the proportion of couples who choose to cohabit, rather than marry or enter into a civil partnership, has increased across all age groups under 85 in the last decade. This can at least in part be attributed to a shift in societal attitudes over recent years, with cohabitation becoming more accepted and widespread. However, when it comes to taxation and legal matters, a formalised union still seems to be the ‘holy grail’.

In this article we look at some of the opportunities for tax planning that exist for married couples and civil partners across the taxes.

Income tax

Married couples and civil partners are taxed independently for income tax purposes, however, in certain circumstances it will, nonetheless, be possible to allocate income between spouses in such a way that maximises use of allowances and tax bands. For example:

Marriage allowance – where one party to the marriage or civil partnership is a non-taxpayer, they may elect to transfer up to £1,260 of their personal allowance to a higher-earning husband, wife or civil partner. This is worth a tax saving of up to £252 for the 2023/24 tax year.

According to HMRC, although more than 3.5 million couples are already benefitting from the marriage allowance, around a further 700,000 couples are eligible but aren’t claiming. In addition, it is possible to backdate a claim for up to four tax years meaning that a couple who are eligible for but have not claimed the allowance could receive a lump sum of over £1000.

Rental income - married couples or civil partners who own residential property jointly are taxed by default on rental income in equal shares. However, where one spouse or civil partner pays tax at a lower rate than the other, it may make sense for them to elect for a greater proportion of rental income from jointly owned property to be assessed on the lower earner. To do this, the couple will first need to own the beneficial interest in the property as tenants in common in unequal shares with the lower rate taxpaying spouse having the greater interest. This can be achieved by the parties executing a declaration of trust stating that they hold the property on trust for themselves in the desired proportions. Subsequent to this, the parties may make a Form 17 election to HMRC electing to be taxed on the rental income in accordance with their underlying beneficial ownership.

Example

Christian and Dean are in a civil partnership. They own a property as tenants in common, which they let out, generating rental profits of £19,200 a year. The property is owned in unequal shares, with Chris owning a 20% share and Dean owning an 80% share. Despite this, in the absence of a Form 17 election the income is split 50:50 and each partner is taxed on rental profits of £9,600.

Chris receives a promotion in March 2023, meaning that he will be a higher rate taxpayer in 2023/24. As Dean will remain a basic rate taxpayer, they decide to make a Form 17 election electing for the allocation of property rental income to reflect their actual ownership shares. This will save them £1,152 p.a. in income tax.

Business owners – business owners may have scope to make their spouse or civil partner a shareholder in the business so that they can participate in dividend distributions. Although the dividend allowance has reduced from £2,000 p.a. to just £1,000 p.a. with effect from 6 April 2023, dividends within the personal allowance will be tax-free; while dividends falling within the basic rate tax band are taxed at just 7.5%.

Capital Gains Tax

Spouses and civil partners are taxed separately on their capital gains and each have their own capital gains tax (CGT) annual exempt amount (£6,000 in 2023/24). Capital gains in excess of this amount are taxed at 10% for basic rate taxpayers and 20% for higher rate taxpayers (rising to 18% and 28% respectively for residential property gains).

Transfers between spouses - spouses and civil partners who live together can transfer assets between themselves on a ‘no gain/no loss’ basis. This provides the opportunity to effectively transfer a capital gain into joint names prior to disposal of the asset to take advantage of two CGT exempt amounts; or to transfer an asset into the name of a basic rate taxpaying spouse to take advantage of a lower tax rate – thereby saving an amount of 10% of the gain. Such a transfer must, however, be made on an outright basis with ‘no strings attached’. This ‘no gain/no loss’ treatment is however only available to spouses/civil partners who are living together (although special rules apply to couples who are in the process of separating or divorcing).

Business asset disposal relief (BADR) - care should be taken where the asset being disposed of is a shareholding in the shareholder’s own company. As many readers will be aware, BADR (formerly entrepreneurs’ relief) reduces the rate of CGT on business assets to 10% (up to a cumulative lifetime limit of gains per individual of £1m). Where those business assets are shares, the person making the disposal must be an employee or director of the company and must have held at least 5% of the company’s ordinary shares for at least two years before the disposal in order to qualify for relief. A transfer of shares to a spouse or civil partner shortly before sale with a view to using two annual exempt amounts could therefore be a costly move if either the transferee spouse is either not an employee or officer of the company or the shares are sold less than 24 months after transfer. Where, however, both spouses/civil partners hold shares in a trading company and each meets the qualifying conditions apart from the fact that one of them holds less than the required 5%, there may be a case for a transfer of shares between them to enable them both to qualify for the relief.

Example

Sarah and James are husband and wife shareholder directors in their family business. James owns 97% of the shares and voting rights, while the remaining 3% are owned by Sarah. They are planning to retire in the next five years and expect to realise a gain of £2m on the sale of their shares.

James decides to transfer 47% of his shareholding to Sarah. The transfer is made on a no-gain no-loss basis. Five years after the transfer, the company is sold with each of James and Sarah realising a gain of £1m. They claim BADR and each pay CGT of £100,000 giving rise to an overall CGT bill of £200,000.

Had the transfer not been made, James would have realised a gain of £1.94m. Having claimed BADR he would pay CGT at 10% on the first £10m and 20% on the remaining £940,000 – a bill of £188,000. Sarah would make a gain of £600,000 but as she would not qualify for BADR she would pay CGT of £120,000 (assuming she is also a higher rate taxpayer). Their combined bill would be £308,000 – an increase of £108,000.

Losses - while it is not possible to transfer capital losses directly between spouses/civil partners, where one spouse or civil partner has losses and the other has gains, a transfer of assets between them could enable one spouse/civil partner to offset their losses against the other spouse’s/civil partner’s gains on subsequent disposal of the asset. Note however that anti-avoidance provisions introduced in 2007 mean that money or assets must not return to the original owner of the asset showing the loss (which may, of course, be difficult to achieve in practice).

Inheritance Tax

It is widely understood that married couples and civil partners can transfer assets freely between themselves without inheritance tax (IHT) implications. The ‘spouse exemption’ applies not only to lifetime transfers between UK domiciled spouses/civil partners but also to transfers made on death either to a spouse/civil partner outright or to an immediate post-death interest trust (IPDI) where the surviving spouse/civil partner has the IPDI or interest in possession.

The combination of the spouse exemption and the transferable nil rate band rules introduced in 2007 means that it is now wholly possible to avoid an IHT liability on first death without losing out on valuable allowances. The transferable nil rate band rules have also been extended to the residence nil rate band (RNRB) which was introduced in 2017.

It is however important to appreciate that the RNRB of both spouses (which is worth a tax saving of up to £140,000) could be lost if the estate on either first or second death exceeds £2m. Married couples/civil partners with a joint estate in excess of £2m will want to preserve this valuable allowance by:

• Equalising estates during lifetime to ensure that neither spouse has an estate in excess of £2m on first death; and/or
• Leaving a nil rate band legacy and/or business assets to children or to a trust on first death to avoid their value being aggregated with those of the surviving spouse on second.

Advice should be sought where one or both spouses/civil partners have previously been widowed – depending on estate values and objectives, it may be possible to make use of multiple nil rate bands/RNRBs by planning ahead during lifetime.

Finally, it is important to note that the spouse exemption is restricted to a lifetime limit of £325,000 where the transferee spouse is non-domiciled. It is possible for the transferee spouse to elect to be treated as UK domiciled (i.e. so as to benefit from an unlimited spouse exemption) however this would then mean that the worldwide assets of the non-domiciled spouse would be subject to UK IHT. As the election can be made either during lifetime or within 2 years of death of the UK domiciled spouse (and backdated to their death), it will usually be prudent to ‘wait and see’ whether making the election would be advantageous – not least because, once made, the election cannot be revoked.

As with all areas of planning, bespoke advice will be essential before taking action to ensure that an election is appropriate in the clients’ circumstances and won’t result in any adverse tax or other consequences.