HMRC has special rules for taxing married couples and civil partners. One of them provides a simple way to reduce your joint tax bill and save a lot of tax. How does it work and what steps are required to put it into action?
Independent taxation
It’s quite shocking to think that until 1990 a married woman’s income belonged to her husband for tax purposes. It was even necessary for HMRC to obtain a husband’s permission to refund his wife any tax she had overpaid. While this antiquated system has been scrapped some aspects remain, but the good news is that these tend to work in favour of married couples.
Income shifting
Whether or not you’re married you (and no one else) are liable to tax on the income to which you’re entitled. What’s more, anti-avoidance rules prevent you from transferring income for tax purposes to your spouse in order to save tax. However, a tax break, which is a throwback to the pre-1990 system, allows couples to shift the liability between themselves and achieve a tax reduction.
Making a joint income election
If you and your spouse jointly own an asset, the income from it is taxed on a 50/50 basis regardless of the proportions in which you own it. For example, if you own 75% of a rental property, and your wife 25%, the rules require you each to declare and pay tax on 50% of the income it generates. However, there is a way around this rule.
Tip. Subject to several conditions you can submit an election to HMRC on Form 17 requesting that you’re each taxed on your share of the income according to your ownership rather than on a 50/50 basis. The rules allow you to stick with being taxed on an equal amount of income for as long as you like and make an election if and when it suits you, i.e. when it reduces your tax bill.
Example. Janet and John own a shop, 75% and 25% respectively. They receive net income of £10,000 per year from letting it. They are both basic rate taxpayers and so it makes no difference to their tax bill whether they are taxed on 50% each or on a 75%/25% basis. However, Janet gives up work to have a child and has no income apart from the rent. The couple make an election on Form 17. As a result, £7,500 of the rent is taxed on Janet but is covered by her tax-free allowance meaning that she has no tax to pay. John pays basic rate tax on £2,500. Without the election John would pay tax on £5,000.
Shift a little income to save a lot of tax
The 50/50 tax rule for married couples can save you tax without the need for a Form 17 election. Tip. Consider transferring a small share of an asset into your spouse’s name if they pay tax at a lower rate than you.
Example. Jill’s shareholdings pay her dividends of £26,000. Her other income is £32,000. Tax at the higher rate kicks in on income over £50,000, and so applies to £8,000 of Jane’s dividends. Her husband Jack has income of £30,000. Jill makes each shareholding jointly owned by transferring a 5% share to Jack. They make no Form 17 election. They are each taxable on 50% of the dividends, i.e. £13,000 each, meaning Jill is no longer liable to higher rate tax and neither is Jack.
By transferring a small share, say 5%, of an asset, e.g. a rental property, to your spouse they’ll become liable to tax on half the income it produces. This can reduce your joint tax bill where one of you pays tax at a lower rate than the other.