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Husband and wife
Today, married couples are taxed as independent persons, each of whom is responsible for their own tax affairs. All individuals are entitled to a basic personal allowance of £5,035 before any income tax whatsoever is paid. The tax bands and rates shown in the box are applied to each spouse separately, so that each may earn up to £38,335 before they start to pay higher rate tax. There is no aggregation of income, no sharing of the tax bands and the basic personal allowance may not be transferred from one spouse to the other.
| 2006/07 Income Tax Rates |
| £ |
% |
| 0 - 2,150 |
10 |
| 2,151 - 33.300 |
22* |
| Over 33,300 |
40** |
*10% on dividends, 20% on other savings income
**32.5% on dividends |
Higher allowances for those aged over 65
The basic personal allowance is increased to £7,280 where the taxpayer is aged 65 or over on the last day of the tax year in question and to £7,420 where the age on that day is 75 or over. This more generous allowance is, however, reduced by £1 for every £2 that the taxpayer’s income exceeds £20,100. It cannot be reduced below the basic allowance of £5,035.
Married couples allowance
In the past, a married couples allowance was available, given in the first instance to the husband. This is now only available to those couples where at least one spouse was born before 6 April 1935.
This allowance can be worth over £600 per year to a couple depending on age but its detailed application is complex. It is worth noting, however, that this allowance can be transferred to the wife or shared between the spouses if they so choose.
Minimising the tax bill
It follows from the basic rules set out above that tax is minimised if husband and wife equalise, as far as possible, their income so that all personal allowances are fully utilised and higher rate tax is minimised.
Example
Alan and Angela have employment income of £100,000 and no savings income.
If this is split equally between them, the total tax bill for the couple is £23,468. If only one spouse has income of £100,000 and the other has nothing, the total tax bill leaps to £31,734 - an additional £8,266!
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Jointly owned assets
Tax Planning
If you and your spouse are both involved in running a business, income will be equalised if you are equal partners or equal shareholders; or, if only one of you is involved, the other could be employed even if only to use up their personal allowance. |
Married couples will often own assets in some form of joint ownership and, if they do not, then it is usually advantageous for tax purposes for transfers to be made to ensure joint ownership. This can have benefits for income tax, capital gains tax and even inheritance tax.
Where assets are owned in joint names any income is deemed to be shared equally between the spouses. If the actual shares of ownership are unequal, income is still deemed to be split equally unless an election is made to split the income in the same proportion as the ownership of the asset. One exception to this rule is shares in close companies (almost all small, private, family owned companies will be close companies) where income is always split in the same proportion as the shares are owned.
Example
A buy to let property is owned three quarters by Helen and one quarter by her husband Mark. If nothing is done the net rental income on which tax is payable will be split 50:50. If an election is made, however, the income will be split 75:25. A choice can be made according to which is most desirable when other income of the spouses is taken into account.
Capital gains tax
Independent taxation also applies to capital gains tax. Each spouse is entitled to take advantage of the annual exemption of £8,800 before any capital gains tax has to be paid.
Therefore it is often most tax-efficient for sales of assets to be made by husband and wife jointly. Transfers may be possible shortly before a sale with no adverse consequences because transfers between husband and wife do not give rise to capital gains tax.
Capital gains tax is payable on the amount of capital gains over the annual exemption at 10%, 20% or 40% depending on the income of the taxpayer in the year of sale.
In effect the taxable gains are treated as the top slice of income and this allows further potential saving if assets are owned jointly, as maximum use can be made of each spouse’s 10% and 20% bands.
Separation
The breakdown of a marriage will often involve the transfer of assets between spouses. The marriage continues until the decree absolute but, for transfers of assets to be entirely free of a charge to capital gains tax, the transfer must be made before the end of the tax year in which the separation takes place. Separation is deemed to happen when the couple cease to live together as man and wife - quite different to the date of the decree absolute which is often much later.
Example
If a couple cease to live together on 30 April 2006, transfers of assets must be made between them by 5 April 2007 for capital gains tax to be avoided.
Conversely, for inheritance tax, transfers taking place before the granting of a decree absolute will continue to be exempt. Even after this date, transfers will not usually be a problem.
There is usually no tax relief on maintenance payments made by one former spouse to another nor on any payments required by the Child Support Agency.
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Children
It is often assumed that children are not taxpayers until they achieve some particular age.
In fact HMRC will tax a child just as readily as anyone else if the child has sufficient income to make them liable.
Transferring income to children
Tax Planning
There is nothing to stop you employing your children in the family business so as to take advantage of their personal allowance provided that they are old enough (generally they must be at least 13 years old), they do not work more hours than is legal and they do actually carry out work for the business. |
Children have their own personal allowances and tax bands. Where their only income is, at best, a few pounds from a paper round or a Saturday job, there may be scope for transferring income producing assets to the children to use up their personal allowance.
The problem is that if the parents do this the income will still be treated as belonging to them (until the child is 18 or marries) unless the gross income arising from such sources is not more than £100 per annum.
However grandparents and others are not subject to this rule.
Children and capital gains
Children also have their own annual exemption for capital gains tax so that assets transferred to them which have a bias towards capital growth rather than income may prove to be more advantageous.
Repayment claims
Where children have significant sources of income from which tax has been deducted, such as bank interest or trust income, they will almost certainly be entitled to a repayment. In such cases a repayment claim should be made.
Child Trust Fund
For children born on or after 1 September 2002 a Child Trust Fund has been introduced. The idea is to encourage tax efficient savings, with the government’s help, to build a savings fund which the child can access once he or she reaches 18. The government’s initial contribution is £250 or £500 for low income families, with a further payment of £250 (and again £500 for lower income families) once the child reaches the age of seven.
Tax Planning
There are still quite a few ways income can be transferred to children tax efficiently:
- buy them premium bonds - winnings are tax free
- buy National Savings Childrens’ Bonus Bonds or National Savings Certificates - these are tax free
- Friendly Societies offer 10 year, tax exempt savings plans for children for up to £25 per month
- a parent can contribute to a pension scheme for a child contributing up to £300 per month gross (net cost £234 per month) even though the child has no earnings.
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Other contributions of up to £1,200 per annum can be added to the fund by friends or family and, although there is no tax relief on making the contributions, the fund is tax exempt. This is therefore a tax efficient medium to which regular transfers can be made.
Child Tax Credit
The Child Tax Credit is means tested and potentially available to families who have responsibility for one or more children. It is a tax free payment made direct to the main carer and it will be available where combined income is less than £58,175 or £66,350 if there is a child under one year old.
Tax Planning
Many couples who are entitled to a tax credit do not receive it because they fail to apply. |
There are several elements to the credit and claims can be complicated. Please talk to us.
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Civil partnerships
All the special rules for married couples, both those dealt with in this section and those covered in other sections of this booklet, apply equally to same-sex couples who have entered into a civil partnership.
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What about unmarried partners?
It still pays to equalise income as much as possible, as income tax will be minimised. However, transfers of assets may be liable to capital gains tax and, if substantial, could also lead to an inheritance tax liability. It is vital for unmarried couples to each make a Will if they wish each other to benefit from the other’s estate at death.
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A word of warning
There is a limit to the extent to which a couple should allow the tax tail to wag the familial dog! To do so has been known to have a high cost in terms of family relationships. There must be as much trust in matters of finance as in those other areas that go with the institution of marriage!
Moreover transferring assets or interests in a business between husband and wife can, and often does, attract the interest of HMRC. This is especially where it is obvious that it has been done primarily for tax saving purposes. Transfer of ownership of an asset must be real and complete, with no right of return and no right to the income on the asset given up.
If a spouse or child is employed in a business it must be a real job for which work is clearly being undertaken and if a non-working spouse is given shares in an otherwise one-person, private company, HMRC may regard this as a sham and continue to tax the working spouse on all of the dividends.
Always seek advice from us to determine the best way to arrange your business and personal affairs within the family unit.
Checklist for couples
- Try to equalise your income.
- Consider placing assets in joint names.
- If you have children consider making use of their personal allowance.
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