Making joint income tax efficient

Income splitting

Since 1990 married couples (and now civil partners) have been taxed independently of each other. However, there remains a legacy from the old system that permits a degree of tax planning for some types of income. They can elect for each to be taxed on half the income or to share the income-producing asset in proportion, e.g. a buy-to-let property.

No election made

Say, for example, that a husband and wife own an asset 75% and 25% respectively from which they receive income. If they don’t make a joint income election they will be taxed as if they received 50% of the income each. Not making an election can save tax.

Example. Lucas is a higher rate taxpayer while Maria, his wife, pays tax at the basic rate. They receive rent from a property of which Lucas owns 90% and Maria 10%. For 2021/22, after expenses the total net income is £15,000 per year. If they make a joint income election and Lucas were taxed on his share (£13,500) and Maria on hers (£1,500), their joint tax bill would be around £5,700 ((£13,500 x 40%) + (£1,500 x 20%)), whereas without an election it would be £4,500 ((£7,500 x 40%) + (£7,500 x 20%)). This is because more of the rental income is being taxed on Maria at the basic rate than on Lucas at the higher rate.

After the election

If ownership of the property were the other way around, with Lucas owning 10% and Maria 90%, they would be wise to make an election so that Maria was taxed on her share of the income. Their joint tax bill would be just £3,300 ((£1,500 x 40%) + (£13,500 x 20%)). However, there’s a catch in making an election. Once made, a joint income election can’t be revoked.

Changing circumstances

If Lucas decides to take a two-year sabbatical from work and during that time his only income is from savings which amounts to less than his personal allowances, he’s not liable to pay tax. The election will now be costing them tax rather than saving it. They would be better off reverting to the 50/50 arrangement, but the trap above comes into play meaning they can’t do it. Changing the ownership of the asset will break the joint income election.

Change of ownership

There might be good reasons why Lucas and Maria don’t want to alter their ownership of the asset even to save tax; however, they only need to make a tiny change in order to break the joint income election. For example, Maria could transfer 1% ownership of the property giving Lucas 11%. From the date of transfer the election no longer applies and they would be taxed on a 50/50 basis on the rental income. The good news is that when Lucas returns to work a new election could be made if it were tax efficient to do so.