A shifty plan that’s tax legit…
The taxman’s golden rule is that whoever is entitled to the income, is the one who has to pay tax on it.
However, there’s always one exception to the rule – is it one you can take advantage of?
It seems blindingly obvious that if you receive income from an investment (e.g. dividends, property income) you’ll have to pay tax on it. But without these rules, someone who’s taxed at the higher rate (a footballer or musician for instance!), could shift their income to someone who doesn’t.
This rule doesn’t always apply to joint income received by married couples or civil partners.
So why’s that?
The taxman’s rules say that married couples and civil partners are taxed on their income from jointly held investments on a 50:50 basis. So if you own 25% of a property that you rent out and your spouse/civil partner owns the other 75%, the taxman still expects you to pay tax on 50% of the income.
If you pay tax at different rates, this might be the cause of a domestic dispute.
So how do you avoid this problem and return to domestic bliss in your household?
If you and your other half own an asset in unequal proportions and you want to be taxed in line with your share (i.e. not 50:50) you need to lodge a special election with the taxman.
You don’t need to make an election if you don’t want to – you can carry on being taxed on a 50-50 basis as long as you like.
You only need to submit the election if and when you decide to switch to being taxed on your actual shares of the asset.
Just to make life more complicated there are some further special rules for civil partners/married couples which we’ll discuss below.
Firstly no matter how you actually share interest earned from a joint bank account, the taxman says it must be taxed 50:50. There’s nothing you can do about this unfortunately.
Secondly if you jointly own shares in a close company (one controlled by 5 or fewer people) then dividends will be taxed in the proportion to your actually ownership so you won’t need to make the election (see above).
However apart from these two exceptions, with some basic planning you should be able to turn the taxman’s rules against him.
If you’re liable to the higher rate of tax (40% or 45%) but your civil partner or spouse isn’t, then shifting your income to them sounds like a good idea, and you can also do this without giving up ownership of the asset completely (see below).
You can transfer a small share of an asset (for example 10%) into your partner’s/spouse’s name and actually shift 50% of the income to them (though only for tax purposes).
Or you could simply put an existing bank account into joint names, meaning you and your partner or spouse will be taxed on 50% of the interest it produces.
Let’s look at an example to see what the potential tax savings are.
John’s portfolio of shares pay’s dividends of £20,000 a year. His salary in 2014/15 will be £65,000 and he’ll have to pay tax at the higher rate on income over £41,865. Mary his wife will have a salary of £18,000 a year, but has no investment income.
John gift’s a 5% interest in all his shares to Mary but doesn’t make an election. This means 50% of the dividend income will be taxed on her, saving nearly £2,500 a year in tax! Not to be sniffed at!
For further details on how to save tax without giving away all your assets to your other half or if you have any other tax queries you have, please feel free to email our friendly tax adviser on email@example.com or give us a call on 01202 048696.
And remember, these tips are not a replacement for professional advice tailored to your precise needs and circumstances.