Will I have to pay tax when I get divorced?

Going through a divorce is a turbulent event that brings about a multitude of challenges, both emotionally as well as financially. The legal process itself is complex and gruelling, consisting of many negotiations and difficult agreements. A key discussion point which inevitably comes about is the division of marital assets, but what often gets overlooked in these considerations are the tax implications that can arise as a result of separation and divorce. When it comes to divorce, untangling shared finances and wealth is not as simple as who brought in what to the marriage as many of us know, but what can unravel consequently are an array of underestimated tax burdens that can further make the process more difficult. This article aims to bring information and clarity so that you can be prepared.

What are marital assets?

Before we delve into the potential tax intricacies, it is first necessary to explain what constitutes marital assets. In the eyes of the law, marital assets are those possessions and belongings that are acquired during a couple’s marriage or civil partnership. They can include everything from personal items, cash in individual bank accounts (not just joint bank accounts), pension pots, and other investments. Furthermore, it does not matter who acquired the assets or whether they were purchased using personal funds. For example, if your partner purchased a car for their own use with their own money, the car would still be seen as a marital asset.

Generally speaking, those assets which are acquired before the marriage, or acquired after receiving the decree absolute (the final court order that confirms the dissolution of the marriage) are not considered to be marital assets. Nevertheless, this does not necessarily mean that they are completely excluded from being divided during divorce which we’ll discuss below.

How are marital assets split during divorce?

When dividing marital assets, what each party will end up with at the end of the divorce proceedings is commonly referred to as the financial settlement. Every financial settlement will be different depending on the unique circumstances of each individual couple. In the UK, it should not be assumed that a 50/50 split is the rule, but a fair and equal divide is often the best place to start when it comes to negotiations. It is in both party’s best interests to mutually agree on their financial settlement, otherwise a decision will be made by the courts. The courts are bound to follow the rules as per section 25 of the Matrimonial Causes Act 1973 and base their decision on various considerations including:

• If there are any children from the marriage under the age of 18, their needs will be considered as first priority
• The age of both parties and the duration of the marriage
• Any physical or mental disabilities from either party of the marriage
• The standard of living enjoyed by the family during marriage
• The conduct of both parties during the marriage
• Each party’s contribution to the marriage
• Each party’s financial needs and responsibilities in the foreseeable future after the divorce
• Each party’s own income or ability to generate income in the foreseeable future after the divorce

Where the courts are involved in the decision of the financial settlement, they have the ability to include pre-marital assets where they see this as appropriate. Additional factors will come into play in such instances such as the duration of the marriage and whether the asset may have become ‘mingled’ as a marital asset. For example, where a property was purchased under one party’s name before marriage but had frequently been used as a holiday home for the whole family, it may then be deemed as fair to be included as part of the marital assets pot. Again, this does not necessarily mean the property will be split 50/50. 

Will I have to pay capital gains tax when I get divorced?

Capital gains tax (CGT) occurs when you dispose of an asset that has increased in value since you first acquired it. To dispose of an asset means to sell it, trade it, or even gift it away. However, one tax advantage that married couples and civil partners share is that they are exempt from CGT on any transfers between one another.  Naturally, the question therefore becomes whether you’ll have to pay CGT on transferring assets as part of your financial settlement when you get divorced.

Previous to April 2023 the rules were dependent on whether the couple were living together or not. Where couples were still cohabitating, any transfers that were made were exempt from CGT and treated as “no gains, no loss”. This means that the asset is not treated as having increased or decreased in value since the original party first acquired it and it continues to hold its original value. However, where couples had separated or divorced, any transfers made where they were no longer living together at the same residence could only be treated as no gains, no loss until the end of the tax year in which they separated. For example, if a couple separated in December 2021, they only had until 5 April 2022 to complete their transfers in order to be exempt from CGT. Any transfers made after the end of the tax year were then subject to the normal CGT rules.

Since April 2023, the rules have since changed, recognising that not all couples could control the timings of their separation. Those who were divorced in March had unrealistic timescales for being able to transfer their assets in time and were therefore unfairly subject to CGT. For couples still living together, the rules remain the same, where they can benefit from asset transfers CGT-free. However, those who have parted ways are now able to transfer assets at the same no gains, no loss treatment for up to 3 years after the year in which they were separated or divorced. For example, if a couple gets divorced in June 2023, they will have until June 2026 to complete their asset transfers without CGT liability. Furthermore, where a transfer of assets has been made due to a court order, the couple will have an indefinite period to complete the transfer without incurring CGT.

If a court order instructs that shared marital assets are to be sold and the proceeds are then to be divided between the couple, then these may be subject to CGT as the transfer is not being made between the couple. For example, if there are several rental properties shared between a couple, the court may order for them to be sold and the profits to be split between the two. However, any profits made in this case will be subject to CGT.

What are the tax reliefs against capital gains tax when dividing the family home on divorce?

Ordinarily, when a married couple sells their marital home, there is no tax to pay because they are usually eligible for Private Residence Relief (PRR). In fact, PRR is not tax relief that is exclusively available to married couples and civil partners, but any homeowner who has owned and lived in their home for the complete duration of ownership. However, when it comes to married couples, the pair can only have one main home in which PRR can be applied to (not a home each). Therefore, depending on how a couple decides to divide the marital home upon separation or divorce there could be implications on claiming PRR.

Even where a couple have divorced, both parties may still be eligible to claim PRR and pay no CGT on any gain made from the sale so long as they both still live in the marital home together. However, more commonly the case when couples do decide to part ways, it is often agreed that one party will move out of the shared home. This can have unfortunate consequences for the vacating party as they may find they become ineligible to claim full PRR as they would not have lived in the marital home for the duration of their ownership. The rules of PRR do however allow a small window of grace, where homeowners can leave their original main residence and move into a new main residence so long as the sale of the original property completes within 9 months from the date of departure.

Since April 2023, the rules of PRR have been relaxed for couples going through a divorce. If one party leaves the marital home and it is sold after 9 months of their departure, they can elect for the original marital home to be still considered as their main residence. This is only possible where they do not attempt to claim PRR on any property they may have owned and resided in during the same time period.  For example, Mr A leaves the marital home on 1 May 2023 and moves into a new home 1 June 2023. The sale of the marital home is due to complete 1 April 2024 which exceeds the 9 month period. Mr A can still claim full PRR on any gain made on the marital home so long as he elects it as his main residence and does not claim PRR on the property he moved into on 1 June 2023.

In some other cases, it may be that either by way of formal divorce agreement or by court order, that one party transfers their interest in the marital home to the party who will remain in the property, yet still retain the right to the proceeds following the sale at some future point in time. In this instance, the vacating party can still claim full PRR so long as the following conditions are satisfied:

• At the point in time where the vacating party leaves, the marital home was still their one and only main residence
• The vacating party transfers their interest in the marital home to the party who remains in the marital home as their main residence

As you can see, the tax rules surrounding CGT upon divorce are highly intricate, so it is advisable to seek professional advice if you’d like to understand your potential tax liability. 

Will I have to pay income tax on my divorce settlement?

Most assets received as part of a divorce settlement falls outside the scope of income tax. Therefore, if the courts order that an ex-spouse is due to pay you £10,000 as part of the financial settlement, the money received is not subject to income tax. However, should you receive any income generating assets as part of your financial settlement, then these will be subject to income tax in the normal way once in your ownership. An example of when this may apply is where your financial settlement includes you receiving rental property or any shares that pay out dividends. The earnings received from either would then be subject to income tax at your own personal income tax band and you are likely to need to complete a self-assessment tax return to declare the income going forwards.

Will I have to pay income tax on spousal maintenance or child maintenance?

If you are the recipient of spousal maintenance or child maintenance as part of your divorce settlement, then you will not need to pay income tax on any amount received for these purposes. This is because the provider of spousal and/or child maintenance will have already been subject to income tax. If you were then to also be taxed then this would be deemed as double taxation. However, you may need to declare any spousal or child maintenance if you claim any state benefits and it could impact how much you are eligible to receive.

Does inheritance tax apply if I’m divorced?

Another benefit that married couples and civil partners share apart from being able to transfer assets CGT-free, is that they are also exempt from inheritance tax. Anything left to a surviving spouse or partner will not be subject to the 40% inheritance tax which is instead applied to their own estate when they eventually pass. What’s more, if you die without a valid will, the rules of intestacy will mean that so long as there are no surviving children or grandchildren, a surviving spouse will receive all assets tax-free.

This automatic inheritance tax exemption only applies until the issuance of decree absolute, unless the transfer of assets after divorce was due to completing an agreed formal divorce settlement or a court order. Any transfers made after divorce and outside of this scope may be subject to inheritance tax. It is important to be aware that should a valid will be created during marriage where assets are left to your spouse or partner, a divorce proceeding does not automatically revoke that will and your ex-spouse or partner could still be entitled to receive your estate. Where this is the case, inheritance tax may then be applied to your estate if it exceeds the inheritance tax threshold.

Get help with divorce tax planning

There’s no need to navigate the complexities of your tax obligation alone if you’re going through a divorce. During such a difficult time, professional help can really make a difference to taking some of the stress away. Our Oxford team of accountants can provide tailored advice to your individual situation, as well as provide a holistic tax plan that will give you clarity and direction. If you’re seeking tax advice and would like to book a tax planning session, please use our online form to get in touch.