Taxation of the Family

Introduction

Married couples are subject to a system of independent taxation which means that husbands and wives are taxed separately on their income and capital gains. The effect is that both have their own allowances, tax bands for income and capital gains tax (CGT) purposes and are responsible for their own tax affairs.

2004/05 Income Tax Rates
£ %
0 - 2,020 10
2,021 - 31,400 22*
Over 31,400 40**
*10% on dividends
  20% on other savings income
**32.5% on dividends

Children are independent people for tax purposes and are therefore entitled to their own allowances and tax bands. It may be possible to save tax by generating income or capital gains in the children’s hands.

Separation and divorce can have significant tax implications. In particular, the following areas warrant careful consideration:

Married couples

Everyone is entitled to a basic personal allowance. This allowance cannot be transferred between spouses. Where one spouse was born before 6 April 1935, a married couple’s allowance is available. This is given to the husband although it is possible, by election, to transfer it to the wife.

In general, married couples should try to arrange their ownership of income producing assets so as to ensure that personal allowances are fully utilised and any higher rate liabilities minimised. Generally, when husband and wife jointly own assets, any income arising is assumed to be shared equally for tax purposes. This applies even where the asset is owned in unequal shares unless an election is made to split the income in proportion to the ownership of the asset.

From 6 April 2004, married couples are taxed on dividends from jointly owned shares in ‘close’ companies according to their actual ownership of the shares. Close companies are broadly those owned by the directors or five or fewer people. For example if a spouse is entitled to 95% of the income from jointly owned shares they will pay tax on 95% of the dividends from those shares. This measure is designed to close a perceived loophole in the rules and does not apply to income from any other jointly owned assets.

Tax Tip
Review the income split between husband and wife. Consider transferring assets to even up incomes. If the husband or wife is self employed their spouse could be employed or taken into partnership as a means of redistributing income. The Revenue may however look closely at such situations to ensure that it does not amount to an ‘arrangement’ to transfer income from a higher rate taxpaying spouse to one liable at the basic rate.

Each spouse’s CGT liability is computed by reference to their own disposals of assets and each is entitled to their own annual exemption, currently £8,200 per annum. Gains above this level are charged to tax by treating them as the top slice of income and using the rates applicable to savings income.

Considerable CGT savings may be made by ensuring that maximum advantage is taken of annual exemptions together with the 10% and 20% tax bands.

This can often be achieved by transferring assets between spouses before sale - a course of action generally having no adverse CGT or inheritance tax (IHT) implications. Advance planning is vital and the possible income tax effects of transferring assets should not be overlooked.

Children

It may be possible for tax savings to be achieved by the transfer of income producing assets to a child so as to take advantage of the child’s personal allowance, starting rate (10%) and basic rate (22%) tax bands.

This cannot be done by the parent if the annual income arising is above £100. The income will still be taxed on the parent. However, transfers of income producing assets by others (eg grandparents) will be effective.

Tax Tip
 A parent can allow a child to use any entitlement to the CGT annual exemption by using a ‘bare trust’, ie an arrangement whereby a beneficiary has an absolute right to property and income, but the trustees are the legal owners.

Children or any other person whose personal allowances exceed their income are not liable to tax. Where income has had tax deducted at source, a repayment claim should be made. Remember that tax credits on dividends are not repayable.

Child Trust Fund

A new Child Trust Fund is to be introduced from April 2005 for all children born from 1 September 2002. The government will provide an initial endowment of £250 (£500 for low income families). Other features of the fund will include:

Child Tax Credit

The Child Tax Credit was introduced on 6 April 2003. The credit which is means tested is potentially available to families who have responsibility for one or more children.

It is a tax-free payment made direct to the main carer.

There are several elements to the credit but broadly the maximum is an annual amount of £1,625 per child together with a family element (one per family) of £545 per annum.

Tax Tip
Many families with children, whether or not the adults in the family are in work, are eligible for the Child Tax Credit. Some credit is likely to be payable in 2004/05 if a family’s income is less than £58,175 a year or £66,350 if there is a child under one year old.

Marriage breakdown

Marriage breakdown often involves the transfer of assets between husbands and wives. Unless the timing of any such transfers is carefully planned there can be adverse CGT consequences.

If an asset is transferred between a husband and wife who are living together, the asset is deemed to be transferred at a price that does not give rise to a gain or a loss. This treatment continues up to the end of the tax year in which the separation takes place.

CGT can therefore present a problem where transfers take place after the end of the tax year of separation. IHT on the other hand will not cause a problem if transfers take place before the granting of a decree absolute on divorce. Transfers after this date may still not be a problem as often there is no gratuitous intent.